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Welcome to the final piece in our three-part ‘bucket list’ series on investing. Part 1 offered what you need to know about TFSAs, while part 2 went into detail on RRSP accounts.

Now that you’re comfortable with TFSAs and RRSPs, you’re probably wondering – ‘How do I know which account type is right for me?’

Since there are so many variables involved with an investment goal – your time horizon, current and future income, tax considerations, and available contribution room – there isn’t (unfortunately) an easy black and white answer we can offer. But we can certainly provide guidance and advice that will help you choose the right account for you.

1) Do you have contribution room in your TFSA?

If the answer is yes, we would encourage you to first maximize contributions to your TFSA. This allows you to withdraw these funds at a later time without a tax penalty and any gains or income earned in the account are tax-free.

This is especially true when you’re younger and/or earlier in your career. While you accumulate RRSP room whenever you have earned income, it’s better to take advantage of this room when you’re in your higher-earning years. Stay with us in this piece until #5 and we’ll go through it in more detail.

There are at least two exceptions to this suggestion. The first exception is that you have an above-average income and/or you’re confident your future income will be lower than your current income. The expected future drop in income could be for a number of reasons, including an upcoming sabbatical, retirement, or even parental leave. In this case you may want to contribute to your RRSP now and 1) receive the tax benefit in a higher tax bracket and then 2) withdraw your funds in the lower income tax bracket scenario. We stress ‘may’ because when you withdraw from an RRSP that contribution room is lost and fresh contribution room can only be earned through future income. Withdrawals from an RRSP are taxed, which is why it’s often referred to as a ‘tax-deferred account’. Ideally, contributions to an RRSP are made at a higher tax bracket and then withdrawn at a lower tax bracket.

2) Buying a house or returning to School? Contribute to a TFSA first, then an RRSP.

The RRSP has programs that allow you to withdraw funds without penalty to purchase your first home (Home Buyers Plan) or study full time (Lifelong Learning Plan). Which may leave you curious why we recommend contributing to a TFSA before an RRSP if these are your investment goals. It’s good to be curious, and we have a really good reason for our recommendation.

TFSAs were introduced in 2009, over 50 years after RRSPs were introduced. The Home Buyers Plan (HBP) and Lifelong Learning Plan (LLP) preceded TFSAs by 25+ years (both introduced in 1992). While the HBP and LLP programs preceded TFSAs, and have merit, they would not be our first choice when saving for a future home purchase or educational endeavour.

Why? The Home Buyers Plan and Lifelong Learning Plan have specific conditions that must be met for withdrawal to be completed without being taxed as income. In addition, the amount withdrawn is subject to maximum limits and must be repaid. In effect, withdrawing funds from your RRSP via either of these two programs represents an interest-free loan from yourself. While that’s not a bad option, the TFSA represents a better option.

Withdrawals from your TFSA can be completed at any time for any reason. There are no conditions to be met and you are not required to repay the amount withdrawn. In addition, withdrawals from a TFSA are not taxed as income. TFSAs provide greater flexibility than either the HBP or LLP. It’s also important to know the full amount of the withdrawal may be re-contributed to the TFSA in the calendar year following the withdrawal.

But, if you’ve contributed up to your personal TFSA limit, an RRSP represents a solid second option to help your savings grow if you see value in either the HBP or LLP. All of the gains in your RRSP grow tax-deferred, which allows for your money to grow faster.

3) Could a modest contribution push you into a lower tax bracket? Contribute to an RRSP.

If you’re earning approximately $50,000 ($47,630 to be precise) or more, it could pay to know what tax bracket you’re in. Since an RRSP contribution lowers your taxable income, it could place you into a lower tax bracket and result in a higher tax refund.

By paying attention to your tax bracket, and putting aside modest amounts of money, you may be surprised how much cash can end up back in your pocket.

Let’s work through two scenarios where your total income last year is $75,000 and you live in Ontario. (If you live elsewhere the impact will be similar and your province is also amazing!). All calculations assume we have taken advantage of the federal and provincial basic personal amount.

Scenario 1: You don’t have a regular savings plan or pay attention to tax brackets. You earn $75,000 a year. Your tax owing would be:

Employment Income Table
Employment Income $75,000
Less: RRSP Contribution -
Taxable Income $75,000
Federal Tax Table
Federal Tax  
15% on first $47630 $7,145
20.5% on next $47629 $5,611
  $12,755
Less: Basic Personal Amount $1,810
Federal Tax Owing $10,945
Provincial Tax Table
Provincial  
5.05% on first $43,906 $2,217
9.15% over $43,906 up to $87,813 $2,845
  $5,062
Less: Basic Personal Amount $534
Provincial Tax Owing $4,528
Total Income Tax Payable $15,473

Scenario 2: You have a regular savings plan that doesn’t really impact your lifestyle, say $75 a week. You read this piece from RBC InvestEase a while back and became aware you’ve just nudged into a higher tax bracket. (You still earn $75,000 a year in this scenario). Your $75 a week represents $3,900 of savings in a year. Your tax owing would be:

Employment Income Table
Employment Income $75,000
Less: RRSP Contribution $3,900
Taxable Income $71,100
Federal Tax Table
Federal Tax  
15% on first $47630 $7,145
20.5% on next $47629  
  $11,956
Less: Basic Personal Amount $1,810
Federal Tax Owing $10,146
Provincial Tax Table
Provincial Tax  
5.05% on first $43,906 $2,217
9.15% over $43,906 up to $87,813 $2,488
  $4,706
Less: Basic Personal Amount $534
Provincial Tax Owing $4,171
Total Income Tax Payable $14,317

The tax payable in scenario 2 is $1,156 less than in scenario 1! That’s literally an extra $1,072.20 in your pocket because you had a disciplined approach to save just $75 a week.

Here’s the best part – that’s your $1,072.20! Of course, we’d love to hear you’ll put all of that money into your RRSP or TFSA. But, we’re humans too – go out for dinner and save some, or add it to your vacation fund. That’s money in your pocket that your discipline has earned.

4) At peak earnings and saving for retirement? – Choose an RRSP.

This is related to exception scenario #2. We’ve trumpeted TFSAs for their flexibility throughout this piece but RRSPs are not without merit. As example #4 highlighted, there can be substantial savings in tax payable when you contribute to your RRSP. If you can contribute to your RRSP in your high earning years and then withdraw in retirement at a lower marginal tax bracket, you’ve done very well! All of the gains and income in your RRSP grow tax-deferred, it’s only at the time of withdrawal that the amount withdrawn will count as income.

Another reason to think about RRSPs in your peak earnings years is the size of available contribution room. For most people in their peak earning years, their available savings may be greater than their available TFSA room. We would always encourage you to save more rather than save less, so putting remaining funds – or all funds – into your RRSP during your peak earnings years, if you are in fact saving for retirement, could be a prudent move.

5) Does the flexibility of a TFSA tempt you to splurge on indulgences? - Choose RRSP.

We might be a robo-advisor in business but in the end, we are people too (really!). That means the flexibility of withdrawing from your TFSA at any time might be a temptation too strong to resist. If you’ve tried to save for retirement in a TFSA before and ended up withdrawing the funds to splurge on a vacation or car, perhaps a restrictive RRSP is better for you. Any withdrawals from your RRSP (not related to the HBP or LLP) will be taxed as regular income and subjected to withholding tax from the government, which for many Canadians is a powerful deterrent against making impulsive purchases with hard-earned retirement savings.

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