Background
Getting the most out of your long-term savings
Saving for the future in Canada means choosing not only what to save for,
but where to put your money. Registered accounts such as RRSPs, TFSAs, and First Home Savings Accounts
(FHSAs) offer different tax advantages and rules,
so the best fit depends on your goals, income, and when you may need the money.
Comparing the merits of the RRSP against the TFSA for long-term savings is a commonly discussed topic.
Before you even get to that point though, there are some priorities that you should take care of first:
Once you have all that in place, and when you're looking to build your long-term savings, you'll have a choice of where to put those savings: either your RRSP, or your TFSA (or both).
How it works
Two accounts. Two different strategies.
An RRSP contribution can be used to reduce your taxable income, which means you pay less taxes, so you can invest more money up-front.
Your investments made within the RRSP grow without being taxed annually.
When you eventually withdraw your money from the account, the amounts withdrawn are added to your taxable income.
A TFSA contribution does not affect your taxes. Your contributions are made with after-tax dollars, so you have less to invest up-front.
Your investments made within the TFSA grow without being taxed annually.
When you eventually withdraw your money from the account, it does not affect your taxes; it is all tax-free.
RRSP
Tax savings now tax payments later
TFSA
No tax savings now no tax payments later
This brings us to the essence of the decision: will the tax savings now (and the investment growth of those savings) outweigh the tax paid in the future? The answer is not always as clear as it might seem.
Beyond the tax brackets
The tax rate you see is not always the rate you get
A marginal tax rate is often described as the tax on your next dollar of income.
But an extra dollar can also reduce an income-tested benefit or credit.
The combined effect is your effective marginal rate,
and it can be quite different from the rate shown in a tax-bracket table.
Here are a few items that may be affected by RRSP deductions or withdrawals:
Weighing your options
Decision factors
Each factor is just one piece of the puzzle. Examine each one to come to a holistic decision.
Working income: This varies for each province, but there are typically increases to marginal tax rates at taxable income levels of around $50,000, $100,000, $150,000 and $250,000. The further up the scale your income is, the more you should favour your RRSP.
Employer pensions:
If you are already contributing to a group RRSP or a pension plan through your work,
any additional savings could favour the TFSA to provide flexibility in your long-term plan.
That said, if you still decide on additional RRSP contributions, ensure you have enough
contribution room. You can find your available RRSP contribution room on your CRA online account,
or on the Notice of Assessment from your last tax return.
Retirement spending:
When you are done working, your income will need to come from other sources.
These are typically the Canada Pension Plan (CPP), Old Age Security (OAS),
any employer pension if applicable, and your own personal investments.
Depending on these sources of income and how much you plan to spend during retirement,
there are a few factors that can affect your marginal tax rate.
For example, the repayment of OAS benefits.
If your taxable income is greater than around $95,000, you will need to repay a
portion of your OAS benefits. The repayment rate is 15 cents for every dollar your
income is over that threshold. This effectively increase your marginal tax rate by
15% if OAS repayment applies to you.
Children under 18:
The Canada Child Benefit (CCB), and similar provincial benefits, are paid to families with children under the age of 18.
The amount paid depends on your family income. Since RRSP contributions can reduce
your taxable income, not only do you pay less tax, but you can also get an increase to the CCB.
The increase to the CCB can range from about 5% to 25% of the RRSP contribution amount,
depending on how many children you have and their ages. In general,
the more children you have and the younger they are, the more value you'll get
from RRSP contributions.
Note that your RRSP contributions will have no effect on the CCB if your
family income is less than $38,000 or greater than $300,000
(exact amounts depend on the number and age of children).
Your age:
The TFSA provides fantastic flexibility due to the withdrawals having no tax implications.
This can be helpful for younger people in the earlier stages of their careers or families,
when there is still plenty of time for life to throw some curveballs. The flexibility from
the TFSA can be a great help when things don't go according to plan.
Additionally, you get your TFSA contribution room back the next calendar year if you need
to make an unexpected withdrawal. RRSP contribution is never restored after a withdrawal;
you have to get more through earning salary or self-employment income.
Your investment strategy: A diversified equity-focused investment strategy favours the TFSA. If you have a combination of fixed-income and equity investments, you should prefer to hold the fixed-income positions in the RRSP and the equity positions in the TFSA.
Marital status: Married or common-law partners can split the taxable withdrawals from their RRSPs once they are at least age 65. This makes it more likely that you can be in a lower marginal tax rate at withdrawal than when you contributed. You can also consider a different type of RRSP, the 'Spousal RRSP'. This allows the higher-income spouse to put money in the account and reduce their taxes, while the lower-income spouse can take the taxable withdrawal later on.
Death:
When you pass away, there is a 'deemed disposition' of your assets,
including your RRSP. This means that the balance of your RRSP is added to
your taxable income in the year that you die. When someone passes away,
especially if it's early and unexpected, this may result in your marginal
rate being higher than when you contributed.
An important factor that ties into the marital status is that a deceased
person can 'rollover' their RRSP to their spouse, avoiding the immediate tax
consequence. All else being equal, the risk of an early death should lead a
single person to favour the TFSA.
Complexity: You may be realizing that utilizing the RRSP to its fullest requires complex planning and tax considerations. If done correctly, the RRSP can indeed be a powerful tool for building long-term wealth. If you fail to account for these factors, using the RRSP becomes less and less effective. On the other hand, the TFSA is very straightforward with no tax side-effects. This makes it much easier to get the full value out of it.
Make the decision with your whole plan in view
Find the right balance for you
In an one-hour planning meeting, we can compare your current tax savings with future withdrawals, benefit impacts, and the flexibility you want. You will leave with clear next steps, not a product pitch.
This article is for general information only, not specific tax, investment, or legal advice. Tax rules, benefit thresholds, and eligibility can change and depend on individual circumstances. Confirm current amounts and rules before acting.