Should you contribute to a RRSP or TFSA? (Part 2)

Hand drawing money sign, "Where to Invest"

TFSA vs RRSP?

Last month I talked about when to use the RRSP vs TFSA. This week I will touch on this topic further.

RRSP’s are optimized when you make contributions when your tax rate is high, with the strategy to withdraw these funds at a later date (like retirement) at a lower tax rate.

Let’s take a deeper dive into this.

Suppose you earn $75,000 per year today. Making a $1000 contribution this year will save you $296 in taxes (29.65% tax rate). When you retire and you have a smaller income (for example, $40,000), you will pay $200 in taxes (20% tax rate) on a $1,000 withdrawal.

This tax savings can be further magnified by the fact that your original $1000 contribution has gained value since it was initially purchased. (The ‘time value of money’ effect)

During retirement, seniors have the ability to split income, including pensions and RRSP/RRIF accounts once over age 65. This can generate significant tax savings.

So why a TFSA then?

TFSA’s are an additional option to help Canadians save that is tax deferred. If you are in a high marginal tax rate, you will want to utilize the RRSP first. If your tax rate is low now, and you expect it to be higher in retirement than it is today, a TFSA is your best option.

All things being equal, if your tax rate never changes from now into retirement, than it makes no difference which one you choose (at least from a tax planning perspective)

The following illustrates this point.

TFSA vs. RRSP

(Notice the after tax outcome after 20yrs is identical when tax rates stay the same)

Source: Investment Planning Counsel, http://www.deferthetax.ca/rrsp_vs_tfsa

 

I would caution you when looking at these options to ask yourself what the intended purpose is for these funds? Tax savings today do have consequences in the future. The TFSA offers tremendous liquidity and the ability to take funds out and re-contribute back in. Once you access funds from an RRSP you can’t re-contribute unless you have RRSP room available.

Although these plans don’t seem overly complicated, making the right decision on how to build them is critical to their success. Mastering the basics is a good start, but seeking the advice of a qualified Financial Planner/Advisor can make a big difference down the road.

Grant Galloway, CFP, CLU, CHS

Financial Planner

Contribute to RRSP or TFSA? Here’s an easy way to know.

tfsa-or-rrsp

On my drive to work this morning, I couldn’t help but notice the $1.16 per litre gas prices… (As we start 2017 with yet another government tax grab on carbon).

I am hoping to help you and your members alleviate some of the tax pain this season with some proper planning!

If you have heard me speak about TFSA’s you will know how passionate I am about these plans. TFSA’s have now been around since January 2009 and they are literally one of the best things the government has given Canadians. The tax-free growth and access on these accounts is obviously the biggest attraction, but they are also a great estate planning tool, giving the ability to name a beneficiary or successor holder allows the funds to bypass the estate and avoid probate.

For 2017 we receive an additional $5500 of new TFSA contribution room, with a cumulative (lifetime limit) of $52,000

(Did you know if you were to max out your TFSA and invest into a conservative portfolio you could have nearly $1,000,000 in 40 years)

The turn of the calendar also brings a new RRSP season, the 2017 RRSP limit is $26,010

I continuously receive questions about the RRSP vs TFSA debate, when should you buy an RRSP? When should you buy a TFSA?

My first reply is YES, always…

Rule of thumb is it depends on your tax bracket, for example in 2017 if you earn over $45,916 you will have a top marginal tax rate of 29.65% this means the next dollar you earn above this income you give our friends at CRA 29.65 cents. Making an RRSP contribution reduces your total income..

Example: If you earn $55,916 in 2017 the last $10,000 you earned you paid $2,965 in taxes; if you made a $10,000 RRSP contribution you would save $2,965 in taxes. Perhaps generating a refund when you file your taxes in April 2018.

 

If you earn less than this $45,916 (24.15% tax bracket) I encourage people to make their savings contributions into a TFSA for now, once their income increases they can always transfer these contributions to an RRSP and still receive a tax refund at that time.

I don’t expect you to provide members with any kind of tax advice, however we would love to talk to them and give them the proper guidance.

Remember a dollar saved in taxes, is a dollar that can be reinvested and compounded over time.

Here is a link to the 2017 Tax Brackets and RRSP & TFSA Limits 

Want to know more about the differences between RRSPs and TFSAs (and which one is right for you?). Here’s an e-book.

Cheers

Grant Galloway, Financial Planner CFP, CLU, CHS

168 King St S Suite 2
Waterloo On
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