Chris’ Corner #5 - To TFSA or To RRSP? That is the question
I have probably heard more misinformation about TFSAs and RRSPs than I have heard the truth. It is not that people are trying to spread lies and lead people astray - I hope. I think it all stems from people being under-educating about registered accounts. I was once filled with misinformation myself. I only had one TFSA that was just getting the 0.5% savings account rate and wasn’t invested in index funds or GICs. I thought I was only allowed one TFSA, and I didn’t realize I could actually invest that money. I honestly thought that a TFSA was just a regular ole savings account - put your money in and get a small return. I have like 3 or 4 TFSAs now; I even have one in USD to avoid currency exchange fees. Do I need 3 or 4 TFSAs - not really - one in CAD and one in USD would probably fit all of my needs. There are no fees attached to any of the TFSAs I have, so if I move my account to another location, maybe get some deal or have access to different markets. I will usually leave the other ones open with $0.00 just in case I want to move my money back in.
There is a lot less misinformation about RRSPs than there is with TFSAs. The RRSP is much older than the TFSA, so less misinformation exists in the world. I hear a lot about RRSPs and TFSAs is which one is right for me? My quick rule is that if you plan on earning more in the future, focus on a TFSA and focus on an RRSP if you are in your peak earning years. The real benefit of an RRSP is benefiting through having a lower tax rate in your retirement years due to having a lower income than you currently do.
I will make a fake scenario involving two people; one earns $45,000 per year and the other $210,000. I am not going to worry about the contribution limits; and they will withdraw their entire retirement account on day one, and both save 10% of their yearly income and their investments both earn 6% a year. I know this might sound like a high school math problem, but it will all come together! I am doing this just to show you how the tax mechanics work for both accounts.
Bob Loblaw - 25 will retire at 55 -Earns $45,000 - Will stay in the same tax bracket in retirement
Tax Bracket - 25%
Yearly Savings - $4,500
TFSA:
$355,761.84: Retirement account balance at retirement
$0.00: Taxes paid when withdrawn
RRSP:
$33,750.00: Total tax savings from RRSP deposits
$355,761.84: Retirement account balance at retirement
$88,940.46: Taxes paid when withdrawn
$88,940.46 - $33,750.00 = $55,190.46
$55,190.46: Net taxes paid after taking into account the tax rebate
$55,190.46/$355,761.84 = 15.51%
15.51%: Net taxes paid to balance ratio
Melissa Melbourne - 25 will retire at 55 - Earns $210,000 - Their planned retirement income will be reduced to $100,000
Tax Bracket - 43.32% Now and 30.50% in retirement
Yearly Savings - $21,000
RRSP:
$272,916.00: Total tax savings from RRSP deposits
$1,660,221.91: Retirement account balance at retirement
$506,367.68: Taxes paid when withdrawn
$506,367.68 - $272,916.00 = $233,451.68
$233,451.68: Net taxes paid after taking into account the tax rebate
$233,451.68/$1,660,221.91 = 14.06%
14.06%: Net taxes paid to balance ratio
If they both used RRSPs, Melissa paid $233,451.68 to the government, and Bob only paid $55,190.46. That does not look at the total paid as a percentage of the account’s total balance when they retire. Bob essentially pays 15.51% of his retirement account balance, while Melissa only pays 14.06% of her account balance.
Bob is better off investing in a TFSA; the tax rebates gained from using an RRSP do not make up for the total taxes. With a yearly retirement savings of $4,500, Bob will not have to worry about hitting the TFSA contribution limits either.
Melissa is in a position to use an RRSP more effectively than Bob. If I were in Melissa’s shoes, I would still be depositing the maximum yearly contribution to my TFSA before making deposits into an RRSP. I am not a fan of paying taxes, and avoiding 100% of the taxes placed on capital gains is worth a lot more to me than simply deferring my tax obligations for future Me. This blog post does not cover all of the aspects of these tax-sheltered accounts. The tax deduction you receive come income tax season from the RRSP deposit comes off of the top, potentially lowering your marginal tax bracket.
A lot goes into planning your finances to take as many advantages as possible. Hopefully, this blog has helped you understand more, and if you have more questions feel free to reach out to us here at Porte Rouge. You can reach me directly at chris@porterouge.co.
