There has been a long-standing debate since the inception of the Tax-Free Savings Account (TFSA) in 2009, whether the TFSA or RRSP is the better investment choice. Which is the better choice from a tax perspective, now and in the future?
Most of us are familiar with and have in our personal investment portfolio the Registered Retirement Savings Account or RRSP. Whatever amount you contribute, you get to deduct from your taxable income, therefore recovering the tax that your employer deducted from your paycheque. If you are self-employed, it works the same way but instead of recovering the tax your employer deducts, it simply reduces the amount you owe. This can be of great monetary benefit if your marginal tax rate is north of 30%. You are basically getting back 30 cents for every dollar you invest before any returns. Not too shabby! Now the downside: yes, you must pay tax on the withdrawals, when that time comes. Now, if you completed some pre-planning with your advisor, you should have determined from the beginning whether the tax bracket in retirement would most likely be higher, the same or lower in retirement. If the answer was anything but the latter, an RRSP would be no benefit to you. The reason being is you would pay the same amount of tax, or possibly more later than you would pay today. In addition, you’re paying for that tax with saved money! Not a good investment as you simply deferred the inevitable.
This most frequently occurs when someone has a robust company pension. If that pension provides an income of $55,000 for example, add to it CPP and OAS and suddenly your income is $75,000 before even taking out your RRSP income! Let’s assume your RRSP minimum is $10,000 and now your taxable income is $85,000. That could be very similar to what you were making during your working years and therefore the same tax liability.
The Tax-Free Savings Account (TFSA) works like this. You contribute what you want, up to the set maximums. It grows in the markets and when you withdraw the money or any part of it, it’s all tax-free. If your tax bracket will be similar or higher in retirement, then the TFSA would have been the better choice. Pay the tax now and have yourself a nice non-taxable bucket of money in retirement to supplement your taxable income. You can have the same lifestyle but control your tax bracket somewhat. Additionally, should you have a situation arise in retirement where you need to access a large chunk of money in one tax year, keeping that chuck non-taxable will ensure no changes to any pension or social benefits such as Old Age Security, Guaranteed Income Supplement, HST return, etc?
Purely from a tax perspective, there is no advantage to contributing to an RRSP or TFSA, if you will NOT be in a lower tax bracket in retirement. If you are in this situation, I would definitely pick a TFSA.
Now, before determining what’s appropriate for your situation, you need to talk to your Wealth Advisor. Your advisor will take into consideration many different variables unique to you, which could change the course outlined above. For instance, pension splitting techniques or deferred CPP or OAS strategies could change things. There are simply too many to write about in one article, so I’ve included only the basic consideration which applies to the majority of people. By taking the time to review your finances annually, and examining all variables closely, your advisor will be able to determine any strategy changes necessary as time goes on and make a professional recommendation based on that.
Here at Brant Financial Group, of Assante Capital Management Ltd., we are very much aware that RRSPs aren’t for everyone. We work closely with our clients to stay informed of their changing circumstances and, by having regular reviews with them, ensure that they always have the most tax-efficient strategy working for them.