I’ll maximize my TFSA first, thanks
Some time ago, I returned home from an annual golf vacation, a “boys vacation” in Myrtle Beach, South Carolina.
Ottawa to Myrtle Beach (and back again) is a long drive, about 30 hours in total, 15 hours each way.
As you can probably imagine, with that much time to kill amongst a few grown men away from their wives for a few days, a host of interesting and surprising topics come up.
One of the topics that arose during our long drive to and from golfing fun was investing, specifically, TFSAs or RRSPs, which is the better investment choice?
I know you’ve heard the debate before: TFSAs are better than RRSPs, RRSPs are better than TFSAs.
Today’s post is about my preference: maximizing my TFSA before maximizing my RRSP account with some very simple reasoning.
So, let’s look at a few tax characteristics of the TFSA:
- Any income or gains earned in your TFSA (from interest, dividends or capital gains) are tax free as the name of the account suggests.
- Any withdrawals from your TFSA are not taxable to you. If you make a withdrawal from your TFSA that amount will be added to the following year’s contribution room. You don’t even have to report withdrawals on your tax return.
- You do not receive any tax deduction from a TFSA contribution; TFSA contributions are made with after-tax dollars.
- As soon as you’re 18 years of age or older, you can have a TFSA. There is no age maximum for this account – you can contribute to a TFSA until life’s bitter end.
- TFSA withdrawals are not counted as income (my favourite).
Overall, pretty amazing stuff folks and those are just the highlights.
Now let’s discuss the RRSP account:
- Any income or gains earned inside your RRSP are tax free until withdrawn.
- Contributions to your RRSP are not counted as income; RRSP contributions receive a deduction based on your marginal tax rate.
- Withdrawals from an RRSP are taxable to you. They will be taxed as regular income regardless of source (from interest, dividends or capital gains) at your marginal tax rate.
- You must convert your RRSP to a RRIF (then start withdrawing), buy an annuity or cash out this account in the year you turn 71. There is an age maximum on this account.
Still very impressive stuff.
I prefer to maximize my TFSA over my RRSP every time.
I’ll qualify this statement by saying the biggest advantage of RRSPs over TFSAs is the tax-deductible contribution you get today and the power it can provide if tax refunds are reinvested going-forward.
Simply put, RRSPs are an amazing tax deferral tool.
If you intend to save for a long period of time (e.g., for retirement over 20+ years) and reinvest your tax refund every year then RRSPs potentially have an advantage over TFSAs.
The RRSP refund is great but it’s actually temporary; you need to give it back at some point.
This makes reinvesting the RRSP refund year after year absolutely critical in my opinion to optimize wealth building – to take major advantage of an essentially long-term but not permanent government loan.
Another reason why I prefer the TFSA over the RRSP is this: simply not all Canadians can consistently max out their RRSP let alone avoid touching the RRSP-generated tax refund each year.
I guess it goes without saying that Canadians who can afford to maximize both RRSP and TFSA contributions would be doing very, very well. Good on them to do so.
The reality is many Canadians simply don’t have enough cash to maximize contributions to both accounts. That’s totally understandable:
- Canadians have a mortgage to pay off,
- They have other loans to pay off,
- They have kids to raise,
- They also want to live for today. Life is short after all.
For these reasons, if you had to pick just one account – max out the TFSA before the RRSP.
Over time, our government will likely find more compelling reasons to tax us. I just don’t see tax rates going lower over time. This will have an impact on RRSP withdrawals but not TFSA withdrawals.
In the end, financial planning is personal. That said, be reminded that TFSAs are a complete tax free gift every Canadian can benefit from.
My plan is to exploit this account for as long as the government lets me. I hope you consider doing the same!
What investment vehicle are you partial to and why? Any feedback or comments for my strategy?
Thanks Mark, your comments as always are very insightful. I have some comments as to why someone would like to draw down their RRSP in their 50s and 60s assuming they have already retired. Normally, most people are still working im their 50s and thus make contributions to their RRSP instead of drawing the RRSP down. What would be the best strategy to minimize tax and to keep their individual net income below the threshold level to avoid the OAS claw back when, say, for example, there is a big capital gain on the sale of a rental property.
Wish you lots of success and prosperity in 2021 and beyond.
Well, I will need to make some strategic withdrawals from my RRSP if I want to stop working and/or if my part-time job in semi-retirement doesn’t cover all expenses.
I know I will use my taxable income to live off dividends in the “early years”. If my part-time job can make enough whereby I don’t withdraw from my RRSP then I will keep monies tax-deferred there. It really “depends” on how much we intend to spend in our 50s. Still planning 🙂
As for the best strategy to minimize taxes, well, capital gains are an efficient form of tax so selling a rental or a cottage is still modestly tax efficient with capital gains inclusion rate still at 50%. It’s a good problem to have in retirement, a tax problem. It means you have a bunch of money.
Wishing you all the best in 2021 as well!
100% agreed with you Mark that TFSA is the best tax shelter to avoid any tax payable. The RRSP a/c is good when you make contribution but when it comes time to withdraw, any amt withdrawn will be added to income.
Mark, do you know what is the amount of net income allowed for 2020 for federal tax purposes before OAS is clawed back? This is a key point to consider for retirees when RRSP is withdrawn and added to income and the total income is over the allowable threshold amount??? and the OAS is clawed back.
Thanks a lot for your assistance Mark.
WIsh you and all our readers a safe, happy and peaceful Xmas and New Year. Hopefully, 2021 won’t be as tumultuous as 2020!!!!
You got it Ken, re: TFSA first then if you have enough income and/or can save enough, then RRSP next. That plan has worked well for me for a decade now.
I think OAS clawback comes in around ~ $79K now.
As you know, for every dollar above that threshold your OAS benefit is reduced by $0.15. That means an individual who is eligible for the current maximum pension of $613.53 a month at age 65 would have their entire OAS clawed back when their net income reaches $128,137.
My plan is to keep my individual net income below that threshold through a combination of income splitting and drawing down my RRSP in my 50s and 60s such that I can take the max OAS (as can my wife) and any income drawn from the TFSA (eventually) is not taxed.
Happy Holidays to you as well Ken!
All good points, but one major point to consider is that RRSP’s are creditor protected while TFSA’s are not.
Excellent point Risk!
P.S. Good post!@My Own Advisor
I suppose an ability to withdraw the proceeds from an RRSP at a much lower rate than when contributing is the ultimate key. @My Own Advisor
Agreed Ian. As long as refunds are always reinvested AND you can assure yourself you’re in a low tax bracket come retirement, I believe in the power of RRSPs as well. I’ll put it this way, I’m not stopping my RRSP contributions anytime soon 🙂 Thanks for your engagement in my post!
@The Dividend Ninja
Thanks for the support and positive comments!
I thought your post was also spot-on, most if not all individuals are far better off maximizing their TFSA contributions first (before their RRSP). It doesn’t mean, if you have the financial means, to do both, then don’t, rather everyone can benefit from tax-free money can’t they???
You and I are aligned; there are hassles with converting RRSPs to RRIFs in the golden years. If I HAVE to do it, I will, but I don’t want to incur more pain than necessary 🙂
Thanks for your comment Ninja!
I kill two birds with one stone and max out my RRSP then use the huge tax return to build up my TSFA.
Sounds like you have a good plan in place that meets your needs badgerb0b! Good stuff and thanks for stopping by!
@The Passive Income Earner
Thanks for stopping by Passive! Agreed, you can always make use of unused contributions if you wanted to later in life; if you get into a very high income situation. That is nice problem to have but that common I would guess for many Canadians with a mortgage, LOCs and the TFSA contribution room to make use of.
Correct me if I am wrong, but assuming my taxation rate is 30 percent (for round numbers), and I contribute $1,000.00 to my RRSP, the net cost to me is $700.00 since the government is willing to refund me $300.00. Using the rule of 72, and a return of 7 percent, that $300.00 should double twice over the next 20 years to $1,200.00. Assuming even the same rate of taxation after retirement, 30 percent of $1,200.00 is $400.00. In other words, for every $1,000.00 I contribute to my RRSP that I can leave in the plan for twenty years, I receive $800.00 more than I would in a TFSA.
Contrary to what was suggested about topping up your RRSP from your TFSA later in life, the power of compounding means contributing more to your RRSP earlier is where the real benefits are achieved.
Thanks for commenting on my blog. I see your math the same way. Over 20 years, using Rule of 72 @ 7% return on investment that $300 (refund) would double every 10 years and be worth $1200 in 20 years. If the same “rules” are used for the rest of the money, that $700 RRSP contribution will be worth $2800. If you reinvested your $300 refund over 20 years, every year, for sure you’ll be ahead with the RRSP by a bit like I mentioned in my post. More money invested and reinvested early = more money generated overall, we agree.
My points are these though:
Over 20 years, instead of $1,000 contributed to your RRSP you only contribute $700 because the TFSA is not pre-tax money like the RRSP is. Over 20 years, using the same “rules” that $700 TFSA contribution is worth $2800, this time all tax-free; same value as the RRSP. You don’t have to pay the government back a cent like most of the $300 refunded, reinvested and compounded for 20 years. During those 20 years you forego the ability to use your $300 refunded each year for your mortgage debt or for investments such as Canadian dividend-paying stocks that get a dividend tax credit; which are far more tax-advantaged investments than any RRSP withdrawal would be. You’re forced to withdraw most of that $1200 earned from the $300 twenty years ago in your golden years and wind RRSP assets down. Not so with the TFSA. If you have enough TFSA assets, you can keep the capital, let the income flow and never wind it down leaving you many more options for your loved beneficiaries. Also, the TFSA money is not impacted by government “income-tested” programs like OAS and GIS whereas the RRSP is. As a senior I want my tax burden as low as possible, regardless what my marginal tax rate is. Thoughts?
When I stopped working, I had half my money in a Trading Account and half in RRSPs. I had a regular RRSP and a Locked-In one for the bits of pension I got from companies I worked for.
When I was saving, everyone was pushing RRSPs. Most of the time I was contributing to my RRSP, I was not in the top tax bracket. However, taking money out of the RRSP, I am in the top bracket. I wished there were TFSAs earlier. (I did save tax free in my RRSP over the years, as a number of people have pointed out.)
If I had to do this again, and had that choice, I would pick the TFSA savings first also.
That is what I’m worried about, although only a bit, being in a higher tax-bracket in retirement than in my working years because to date, I am fortunate enough to have a defined benefit pension plan. While the tax-deferral today is great I will be paying taxes on withdrawals at some point, when converting RRSP to a RRIF. As Dividend Ninja said, “why have extra taxation in retirement, to save taxes now?” No thanks if I can do something about it. Thanks for stopping by Susan, I continue to follow your dividend investing approach, not to mention success!
I am all for the TFSA as well. With the RRSP vehicle you are simply deferring your taxes for the future. Having said that, one might exploit the RRSP in a high income year and withdraw the funds in a year where he loses his job for example. What do you think?
Totally agree. If one was in a high-tax bracket for one year or many years, I would most certainly try to put lots away in the RRSP. For now, that’s just not me 🙂
Thanks for checking in!
I make 103Kper year, would I still benefit from TFSA? My employer matches RRSP so I maximize that. It’s about 10K per year in RRSPs that are saved yearly. Would you leave that and then invest in TFSA?
My personal feeling Deysi is all Canadians can benefit from tax-free money. Is that something that interests you? Tax-free income and/or tax-free growth?
The RRSP is not tax-free by the way, even an employer supported RRSP. The RRSP is a tax-deferred account…
Does that help a bit?
forgot to ask another questions, what about US investments? Is the TFSA still worth it if I get taxed 15% or should I put US investments in RRSP to avoid the 15% and still get dinged on the income anyway?
Check out these pages….
Unfortunately U.S. stocks or U.S. ETFs and funds, are expected to have 15% withholding taxes on dividends and distributions inside the TFSA.
You’ll read on those pages, U.S. stocks or U.S. funds that trade on the U.S. market, do not have those withholding taxes when such assets are held inside the RRSP, LIRA, RRIF.
When U.S.-listed ETFs are held directly in an RRSP, or other registered retirement account, such as a RRIF or locked-in RRSP, investors are exempt from withholding tax from the U.S. (but not from overseas countries).
So….owning U.S. listed ETFs or stocks, all things considered, are said to be “best” from a withholding tax perspective. Example: with a low-cost diversified equity ETF in your RRSP or RRIF and not inside your TFSA – since it is exempt from all dividends from the 15% U.S. withholding tax; if the dividend yield is 2%, then you should save ~0.3% per year from a withholding tax perspective you put this ETF in your RRSP or RRIF or LIRA.
Hope that helps some of your decision-making!
MOA, this is a GREAT post! Well done..
Regardless of income I argued explicitly in a previous blog post that an individual is far better off maximizing their TFSA contributions first (before their RRSP):
The basic premise is you don’t have to pay taxes on your withdrawals from a TFSA, but you do with an RRSP. In an RRSP, that amount happens to include all your compounded income on top of your original investment – which can amount to a huge amount over time. Then there are all the hassles of converting your RRSP at age 71.
Whether you are a high income or low income earner, lower tax bracket in retirement or not, you still will pay exta tax on your RRSP withdrawals – so you will always be better off with a TFSA. I know a lot of people will disagree with me on that, but why have extra taxation in retirement, to save taxes now?
There is one situation where an RRSP contribution makes sense. For people who don’t have secured collateral for a line of credit for investing, or their own home for a HELIOC etc. the RRSP loan makes sense, becuae the interest rate on an RRSP loan is very competitive. Its a cheap way to borrow for investing.
That sounds like a fun trip!
This decision would be a lot tougher for me if I didn’t have a defined benefit pension plan. Since I do, the TFSA definitely gets preferential treatment as far as my savings priorities go.
I do have about $45k in my RRSP that I saved up before moving into the public sector. Assuming it grows to a few hundred thousand in the next 20 odd years I might use it as part of an early retirement plan and melt down the RRSP from age 55-64.
It was a great trip Echo. I too, might meltdown the RRSP as part of an early retirement plan. It all depends how those dividend-paying stocks grow and mature for me 🙂