Tax Tip Thursday
RRSP Considerations
It is RRSP Season! So I thought I would talk about the difference between short term thinking and long term thinking. Or, in other words,
RRSPs vs TFSAs
They have some similarities, but in general are very different!
Similarities
In both cases, there are limits to the amount that you can contribute. There are three ways you can find out what those limits are for you personally:
- Both limits are available in your MyCRA account. I know I am always saying you should have one, and once again here is a good reason!
- Your RRSP limits are on your notice of assessment
- If you sweet talk your accountant (since you don’t have a MyCRA account), they might look it up for you
Both a TFSA and RRSP can carry forward unused amounts indefinitely until you decide to use them.
There are also some similarities in terms of leaving them to your beneficiaries, but there are significant difference that you want to be aware of for your estate (more on this later).
You can put a very wide variety of investments in either one.
Differences
There are a lot more differences than there are similarities, so I will lay them out in a table for you:
| RRSP | TFSA |
|---|---|
| Generate a reduction in taxes when you make the contribution, saving you up to 53% in taxes! | Do NOT generate any tax reduction |
| Are tax sheltered (or deferred, really) while they are in the RRSP. Once you take the funds out, you will be taxed at whatever rate is applicable when added to the rest of your income. | Tax sheltered forever, even when you withdraw funds. They really are TAX FREE! |
| If you withdraw any money at any time from your RRSP you are taxed on it and the contribution room is lost. | If you withdraw money from your TFSA, the funds you withdrew get added back to your unused contribution room for next year! So you can put it back later on with no penalty. They are also not taxed. |
| Can be left to your spouse fairly easily without any tax implications as long as they are designated properly when withdrawn. BUT you cannot leave them to anyone else (except a dependent child) without tax consequences. | Can be left to anyone tax free. |
| You cannot contribute to your RRSP after you turn 71. | You can contribute to your TFSA at any age. |
| RRIFs CAN affect your OAS income if you make $76,000 or more. It will begin to be clawed back at a rate of $15 per $100 over that threshold. | TFSAs have no effect on your OAS. |
What Does It All Mean?
I don’t blame you for still wondering. If you’d rather, please don’t hesitate to book an appointment and I’ll be happy to help you understand!
It might not look like it from the table above, but there really is an up front/short term benefit to contributing to an RRSP. And, depending on what income bracket you are in, they can be quite significant! For those who do not have significant income, there are some pretty significant downfalls to using RRSPs in my opinion. So you really need to consider this carefully. It might be tempting to pocket that refund, but depending on your taxable income, it might not be in your best interest in the long term.
On one hand, if you make less than $50,000, I wouldn’t be making an RRSP contribution. I think you will be much better-served putting your money into a TFSA — ESPECIALLY if you are under 30! You can save the room in your RRSP for when your income is higher and the benefit will be greater.
On the other hand, if you make $100,000, I think you should be contributing to your RRSP. The tax savings at that rate are almost 40%!
Regardless, the decision is personal and should be considered very carefully.
Here is an example:
If you have an income of $50,000 and contribute $5,000 to an RRSP this year, you will receive a tax benefit of approximately 30% — that’s $1,500. If you leave the $5,000 in your RRSP for 20 years at a rate of 6%, it will be worth approximately $16,000. If you then have an income of $50,000 in your retirement, you will still have a tax rate of approximately 30% which means that your $16,000 is only going to be worth about $10,000. The exact amounts depend on how you take the money out and many other variables, but my point is that your $5,000 investment will net you $1,500 up front and will only be worth $10,000 in 20 years.
Now on the other hand, if you contributed the $5,000 into your TFSA, you would NOT receive the $1,500 right now. But you would probably have spent it anyway, right? Regardless you will STILL have the $16,000 in the TFSA in 20 years regardless of how you withdraw it, and you will get it tax free!
So with the RRSP route, you get $1,500 now and $10,000 in 20 years. With the TFSA, you get $0 now and $16,000 in 20 years. Which is better for you?
For me, combined with all the other negative attributes of the RRSP, I would be using the TFSA in this situation.
Keep in mind, though, that every situation is different! So please be sure to talk to a professional to get advice that is specific to YOU and YOUR situation. For some people the right answer might be RRSP while others it should be a TFSA. Or maybe the right answer is a combination! There are a lot of variables and strategies, and getting the right advice could be 10s of thousands of dollars or more to your benefit.
Disclaimer:
This article provides information of a general nature only. It is only current at the posting date. It is not updated and it may no longer be current. It does not provide legal or tax advice nor can it or should it be relied upon. All tax situations are specific to each individual. If you have specific tax questions you should book an appointment for a 1 on 1 consultation.