2017-Dec-13 When to invest in your TFSA or RRSP

2017-Dec-13 When to invest in your TFSA or RRSP

Dear Investor,

The federal government has announced that the Tax-Free Savings Account (TFSA) contribution room for 2018 will increase by $5,500. So, if you were 18 years old or older in 2009 and have been a Canadian resident, your total contribution room is now $57,500. To determine your contribution allowance, check your 2016 tax return statement from the Canada Revenue Agency. So should you invest in your TFSA or RRSP?

The TFSA is an excellent investment vehicle and, in many ways, is superior to its beloved cousin, the Registered Retirement Savings Plan (RRSP). Canadians seem to be catching on as in 2015 the Office of the Superintendent of Financial Institutions (OSFI) reports that 30% of taxpayers contributed to their TFSAs versus 23% to an RRSP. So, when should you contribute to your TFSA instead of contributing to your RRSP?

Contribute to your TFSA first,

  1. If you believe you will be in a higher tax bracket in retirement than you are in today (for example, perhaps you may receive a generous pension).
  2. If you need to withdraw money from the account prior to retirement.
  3. If you want to maintain your eligibility for income-tested federal government benefits, such as Old Age Security (OAS), as RRSPs are considered and taxed as income when withdrawn.

The main difference between the two vehicles is that with the TFSA you invest after-tax dollars and with the RRSP you invest pre-tax dollars. This is probably best illustrated with an example. If today, you are in a 30% tax bracket (and assume you will still be in a 30% tax bracket in retirement) and have $10,000 before tax to contribute to either the TFSA or RRSP – what does this look like?

TFSA: $10,000 less $3,000 in tax = $7,000 invested. If the $7,000 grows at 6% for 25 years, you will end up with $30,043 and won’t pay any tax when you withdraw it.

RRSP: $10,000 is invested. If the $10,000 grows at 6% for 25 years, you will end up with $42,919. However, when you withdraw it, you will pay 30% tax ($12,876) which also leaves you with $30,043 – exactly the same as the TFSA.

Of course, if you believe you will be in a lower tax bracket in retirement then you should invest in your RRSP or if available both.

Kind regards,

Haakon