4th Annual Dollars & Sense Survey: Turning up the heat

One of the benefits of living in an interconnected world is that we can draw on the experiences and lessons from different countries to successfully manage new product rollouts in Canada. While other countries don’t have the exact same Tax-Free Savings Account setup as we will, it’s still worth looking at similar products around the globe to understand how we can use the TFSA to our clients’ advantage.

As I mentioned in my last column, the TFSA is a hybrid of a taxable account and an RRSP. Although the maximum annual level of contribution is initially set at $5,000, the potential inflow of money (there is an annual ceiling of $130 billion) suggests the impact on your advisory business will be substantial and multiply over time.

That assumes, of course, that you apply some of the lessons learned from two similar products — the Roth Individual Retirement Account (Roth IRA) in the United States, and the Individual Savings Account (ISA) in the United Kingdom. Both these products are similar to TFSAs, and both are designed to supplement and help manage income from other forms of saving. The track records of these products over the past decade also indicate that it’s going to take work on the advisor’s part for the TFSA to achieve investor acceptance.

Since their introduction in 1998, Roth IRA assets have grown to an estimated $225 billion US. They have been adopted by 15% of U.S. households, compared to 33% of households that have traditional IRAs, the equivalent of our RRSPs. In the U.K., ISAs have attracted nearly 15 million account holders, and are now estimated to account for assets of close to C$582 billion. Interestingly, the number and value of contributions to ISAs grew roughly 8% last year, despite widespread fears of an economic downturn. Falling consumer confidence typically erodes saving intentions, so the strength of ISA sales is encouraging.

In both the U.S. and the U.K., these vehicles have proven important asset gatherers for the firms that provide them. Research in the U.S. indicates that households owning Roth IRAs tend to be younger and have higher incomes than those owning traditional IRAs. Roth IRA owners are also more likely than traditional IRA holders to make contributions, and to make relatively greater contributions when they do. In the U.K., ISA holders are also better-off investors.

Before I discuss some of the lessons we have learned from Fidelity’s international experience, it is useful to compare TFSAs with their foreign counterparts. Let’s start with the Roth IRA. Like the TFSA, it has an annual contribution limit of US$5,000 per person (US$6,000 for contributors age 50+) and, similar to a regular IRA or a Canadian RRSP, allows for a wide range of investments (mutual funds, stocks, bonds and other interest-bearing instruments).

There are significant differences, however. While anyone can make the maximum contribution to a TFSA, Americans can only make the maximum contribution if their gross income is below a specified threshold (in 2008 the threshold is $101,000 or less, or $159,000 for joint filers). Another difference is that Canadians face no restrictions on tax-free withdrawals, but U.S. residents have to wait a “seasoning period” of five years, and be at least 59-1/2 years of age, before they can withdraw tax-free from a Roth IRA. And while TFSAs are positioned as multi-purpose savings vehicles, Roth IRAs are primarily meant for retirement savings.

TFSAs are more comparable to ISAs in the U.K. Both have predetermined annual contribution levels, although in the case of the ISA, you can invest up to about C$6,980 in a cash ISA and around C$13,971 in a stocks and shares ISA within an overall annual savings limit of C$13,971. Neither a TFSA nor an ISA places limits on contributions on the basis of income, neither plan imposes withdrawal restrictions, and both are meant as multi-purpose investment vehicles. When initially introduced, ISAs were quite complex, and have since been modified a number of times over the years in efforts to make them easier to use. That said, research suggests that some confusion remains over the benefits of the accounts. The one significant difference is that TFSAs allow a mix of investment content similar to an RRSP, while ISAs, as mentioned, are split into two types.

How readily will Canadians accept TFSAs? Given the greater comparability between TFSAs and ISAs, it is perhaps more useful to look at Fidelity’s experience in the U.K. As a group, U.K. investors are generally uneasy about investing in stocks. U.K. investors are considered naturally risk averse and apprehensive of the unknown; they do not like cyclicality, and they balk at new products that may be hard to understand (and as initially introduced, ISAs were difficult to understand). Similar claims could be made about investors anywhere, including Canada. However, research in the U.K. tells us ISAs are more successful where providers have transparent brands — which reflect an organization’s innate values, clarity of product presentation and straightforward client care. These are more likely to be trusted by investors.

Fidelity’s ISA experience also tells us that sustained, clear marketing and education will be needed to inform clients about the basics of TFSAs, mollify potential fears, and advise clients about the tax savings and benefits. Familiarity, you might say, will breed acceptance. This is particularly true in approaching younger savers. In the U.K., ISA ownership is heavily skewed to people aged 45 and over, but younger savers present a huge potential market because they have the time to build significant TFSA assets. These younger clients will also present valuable future cross-selling opportunities. It is important then, to promote the accessibility and flexibility of TFSAs. Advisors also need to understand their clients’ motives for using TFSAs (for immediate shorter term goals such as house deposits, or for long-term savings such as retirement planning) and to make sure information about them is readily available through as many channels as possible, including the Internet, a route younger clients are more likely to use.

While we’re still a couple of months away from the TFSA’s implementation, by looking at its counterparts in the U.S. and U.K., advisors can be better prepared to give their clients a bigger bang for their buck.

Michelle Munro is director, tax planning, for Fidelity Investments Canada. She can be reached at michelle.munro@fmr.com.

(10/08/09)