Decisions, decisions — is it better to contribute to investments held within an RRSP or a TFSA?
You have limited funds and you’re wondering whether it’s better to put them in your Registered Retirement Savings Plan (RRSP) or in a Tax-free Savings Plan (TFSA) eligible investments.
That depends on two factors:
1. How frequently the funds will be removed from and re-contributed to either investments within an RRSP or TFSA in the years leading up to your retirement. If you are going to need the funds prior to retirement and intend to re-contribute them at a later date, a TFSA may be the better option because you can make withdrawals at any time and the contribution room is restored; but when you make RRSP withdrawals, you lose that contribution room.
2. What your marginal tax rate is today and what your marginal tax rate will be when you finally remove the funds. Generally, if your marginal tax rate is lower at the time the funds are removed from your registered plan at retirement, the RRSP option will usually produce a better result — but that is only true if your marginal tax rate actually is lower.
Your marginal tax rate can be influenced by income-tested benefits including the Age Credit, Old Age Security (OAS), the Guaranteed Income Supplement (GIS) and the GST Credit. Because they are income-tested benefits, they are reduced or clawed-back as your income increases, ultimately disappearing entirely at an upper threshold that is different for each of the benefits.
If the funds you remove from your RRSP after age 65 increase your taxable income and result in the loss of some or all of your income-tested benefits, you will have effectively — and perhaps substantially — reduced your income and increased the tax you pay. And you would have cancelled out some or all of the value of your RRSP withdrawal.
There is no doubt that RRSPs and TFSAs play key roles in financial and retirement planning and there are strategies — like income-splitting — that you can use to reduce your taxable income and avoid clawbacks.
Your professional adviser can help you decide what’s best for your situation.
J. Kevin Dobbelsteyn is a certified financial planner with Investors Group Financial Services Inc. His column appears every Wednesday.