By: Robert Bradburn, Wealth Management Specialist, CWB Wealth Management
The great debate
There are certain topics which are best left alone at a Canadian dinner table: religion, politics, taxes. The past eight years of debate over the best way to beat the tax-man while saving for retirement has largely revolved around the Tax Free Savings Account (TFSA) and the Registered Retirement Savings Plan (RRSP). It seems no one can offer a definitive answer on which is the best savings strategy and it’s likely that no one will. However, a proper understanding of these two options can help in figuring out which strategy fits best with your own personal needs.
First, it’s important to remember that a TFSA or a RRSP by themselves are registration types – not actual investments. You can’t “buy an RRSP” but you might buy a GIC or a mutual fund (investment) for example, within a RRSP (registration). Secondly, both options are structured differently in how they protect you from taxes.
TFSA's
Think of a TFSA as a parking garage that shelters vehicles (investments) from the rain (tax). If you park a vehicle outside of the garage, it’s going to get caught in the rain. Once you park your vehicle inside the garage, it is sheltered.
Think of a TFSA as a parking garage that shelters vehicles (investments) from the rain (tax). If you park a vehicle outside of the garage, it’s going to get caught in the rain. Once you park your vehicle inside the garage, it is sheltered.
You can fit any type or number of vehicles inside the garage; from savings accounts to mutual funds regardless of their value, as long as the amount you paid for them doesn’t exceed the total contribution limit (which is $46,500 for 2016 and $52,000 on Jan 1, 2017). As long as you sell your vehicle while it’s in the garage, you will not get wet. When you walk out of the garage with the proceeds in your pocket you will not be taxed.
RRSP's
From a tax-sheltering perspective, an RRSP can also be thought of as a parking garage. That is of course, in some universe where the parking attendant is so happy to welcome you to the garage he actually gives you money at the booth (aka your tax-return: the value of the dollars you’re putting into the RRSP multiplied by your marginal tax rate.) So unlike a TFSA, it pays you to park in the garage but charges you when you leave. While you’re parked in the garage, your vehicle stays dry and sees no taxes.
So unlike a TFSA, it pays you to park in the garage but charges you when you leave. While you’re parked in the garage, your vehicle stays dry and sees no taxes.
When you sell your vehicle inside of the garage you also see no taxes. When you walk out of the garage with the proceeds in your pocket, you will have to pay the attendant back (tax = amount taken out of the RRSP multiplied by your current tax rate. This money is viewed as regular income). Also, because the money is now deregistered, any future growth will be taxed.
The right choice for you
So when does it make sense to choose one over the other? Or should you be using both? The answer is it depends. Each situation is unique and there are multiple factors to consider. For example, what is the tax bracket you fell in when you put investments into your RRSP versus your anticipated income when you take it out? What are the chances you will need to use that money prior to retirement? The rule is to be in a higher tax bracket when you contribute to a RRSP and a lower one when you withdraw.
If you spend more time planning your next vacation than you do planning an investment strategy that leverages each of these tools to their maximum advantage, it’s time to talk to a professional. A CWB Retail Account Manager will get to know your short and long term plans and work with you to find the right combination of investments. With a full range of registered accounts, GICs and mutual funds*, we can help get you on the right path to retirement.
* Mutual funds are offered in-branch through Canadian Western Financial, a CWB Wealth Management Company