Yes, you should have both a TFSA and an RRSP
It’s awards season again. And the red carpets are unrolling so thick and fast that they’re becoming a pedestrian hazard. In the lead-up to Academy Awards next month, we’ve already seen the People’s Choice Awards and the Golden Globe Awards in the entertainment business, with the usual panoply of celebrities in various stages of dress and sobriety. So in the spirit of the season, I’d like to propose by own “Best Saver Award.” And this year, the award goes to…you – if you have both a TFSA and an RRSP in your financial plan!
Sadly, though, many of us put off contributing to a Tax-Free Savings Account (TFSA) if we already have a Registered Retirement Savings Plan (RRSP). I’m often asked whether it even makes sense to open a TFSA if you haven’t maxed out your RRSP contributions. I answer with a resounding “Yes!”
RRSPs get taxed…eventually
Here’s why. It’s all about withdrawals. With an RRSP, you have to ask two basic questions: What is my marginal tax rate when I contributed to the RRSP? What will be the marginal tax rate when I plan to withdraw the funds from my RRSP?
In most cases, people assume that when they retire, they will be in a lower tax bracket. But if you expect to be in a similar or even higher tax bracket in retirement as you are when you’re working, then it might make more sense to load up your Tax-Free Savings Account (TFSA) to the maximum levels each year. That’s because in a TFSA, the money will not be taxed when it is withdrawn from the account.
With an RRSP, you get a tax deduction for contributions you make, and money in the RRSP grows tax-free until you withdraw. Withdrawals from your RRSP are taxable at your marginal rate at the time of withdrawal, so if you expect to be in the same tax bracket at retirement as you are now, then you’ll pay tax on withdrawals at the same rate as you do now. At maturity, you can, of course, roll over your RRSP into an annuity (very low rates at present) or another plan, like a Registered Retirement Income Fund (where withdrawals are still taxed at your marginal rate), but this is another story.
When withdrawing from an RRSP at retirement, you will want to make sure that you keep your income below the Old Age Security income threshold, or your OAS benefit will be “clawed back.” Essentially you would be giving “free” money back to the government.
TFSAs go tax-free…forever
Contributions to a TFSA, on the other hand, do not give you any tax deduction or credit. In addition, contribution limits, and thus your immediate tax deductions, are much higher for an RRSP. (Note that annual TFSA contribution limits are indexed to inflation, and are increased periodically at a set rate by the federal government.) However, money in a TFSA grows tax-free, and withdrawals, which can be made at any time, are also tax-free. In addition, withdrawals from a TFSA at retirement have no effect on your eligibility for federal income-tested benefits, such as Old Age Security.
You can see the advantages of having both TFSAs and RRSPs for retirement savings. Both types of plans are excellent ways to accumulate wealth for retirement in a tax-advantaged way. So my advice is to use both TFSAs and RRSPs as part of your integrated savings plan – and you too can become a nominee for the “Best Saver Award.” Note, though, that there are no red carpets or statuettes involved – just a nice fat nest-egg when you’re ready to retire.
© 2014 by Robyn K. Thompson. All rights reserved. Reproduction without permission is prohibited.
