In an ideal world, you would maximize your contributions to both RRSPs and TFSAs. Most Canadians, however, can’t afford to do that while paying a mortgage, helping their kids through school and keeping up with the Joneses. So, what’s the best way to maximize the investment dollars you have this year and moving forward?
As a basic strategy, an RRSP is ideal if you’re in a high tax bracket that will continue until retirement. TFSAs, on the other hand, are ideal if you require more flexibility and don’t want to worry about taxes on your withdrawals in retirement.
Both RRSPs and TFSAs shelter you from tax as long as your investments are held within your account, but differ in two important ways. With an RRSP, you can deduct the contribution from your income, which earns you a tax refund, but the money becomes fully taxable when you take it out. A TFSA is the reverse: You don’t get a tax break on contributions, but you don’t pay tax on withdrawals either.
So, what should you do?
The best answer is that it depends on your tax rate. If you’re in a higher tax bracket when you contribute the money than when you expect to take it out, it’s better to use an RRSP. Make the contribution now and take the tax receipt; then when you withdraw, you will be making less money and will be taxed at a lower rate. On the other hand, if your income is expected to increase in the future, it’s better to go with a TFSA and avoid the higher RRSP tax rates on withdrawal.
That is the best general answer I can provide, but it’s not a rule – it’s impossible to know what tax bracket you’re going to be in 10 years or a few decades from now. The RRSP has made sense for many years, as most Canadians earn about 70 per cent in retirement of what they earned while working. This lowers their tax bracket and makes an RRSP the ideal choice.
However, a TFSA may be the better choice if you value flexibility and potentially need to withdraw money while still working. Withdrawing from a TFSA never has a tax impact, and a TFSA allows you to reinvest that money the following calendar year. This contrasts with an RRSP, which you are forced to convert to a RRIF the year you turn 71, and then make the minimum withdrawals.
When you start drawing down your savings in retirement, RRSP and RRIF withdrawals count as income, whereas you don’t pay any tax on TFSA withdrawals.
Your best option is to reach out to a financial advisor and have them review your situation in detail to determine which is best for you. They can guide you through many important factors that may sway your decision, such as if your employer offers RRSP matching or provides a defined benefit pension.
After a conversation with your financial advisor, the choice will become much clearer and you will feel confident that you’re on the right track.
Chris Mills is a financial advisor with Raymond James Ltd. The views of the author do not necessarily reflect those of Raymond James. This article is for information only. Raymond James Ltd., member — Canadian Investor Protection Fund.
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