In the media, Registered Retirement Savings Plans (RRSPs) and Tax-Free Savings Accounts (TFSAs) seem to be presented as an either/or choice, leading investors to favour one over the other. However, both account types offer distinct benefits that can help you manage taxes and boost after-tax dollars. Further, by utilizing both accounts, you gain an additional layer of flexibility to help maximize the benefits of each account.
Let your RRSP tax savings build your TFSA
Your RRSP offers some well-known tax advantages, including the ability to claim your RRSP contributions as deductions against your income, and potentially receive tax refunds. By choosing to put your savings into your RRSP first, and using your RRSP tax refunds to contribute to your TFSA, you can build more assets for your retirement.
The flexibility of two accounts
When your tax rate is relatively high, and you require additional income, drawing savings from your TFSA can make a lot of sense. That’s because you can withdraw funds without paying taxes at your current high rate, and the amount you withdraw is added back to your available contribution room the following year. On the other hand, because RRSP/RRIF withdrawals are taxable, to maximize the benefits, withdrawals are ideally made when your income is relatively low and/or your tax-rate is lower than when you made your contributions.
It also makes tax-sense to own certain assets classes in your RRSP vs. your TFSA. Owning foreign securities (i.e. U.S. or ADR) in your RRSP helps you to avoid the withholding tax on foreign dividends, therefore keeping more in your pocket. Owning fixed income in your TFSA is a great way to keep more of your interest income (otherwise taxed 100% at your marginal tax rate) and maintaining liquidity potentially needed for withdrawals. By building assets in both your TFSA and RRSP, you have the flexibility to draw income from the account that best suits your current tax or income scenario while diversifying your portfolio tax-efficiently across various asset classes.
Benefits before and during retirement
For most people, their retirement income will be lower than throughout their career, providing a natural time to take advantage of lower tax rates to withdraw from their RRSP, and eventually their RRIF (your RRSP converts into a RIF in the year you turn 71). That said, life seems to happen when we least expect it and our income needs are not always consistent over a lifetime.
Pre-retirement, you may take time off to take care of family, for education, sabbaticals or other personal reasons. Post-retirement, income can also vary significantly if you retire prior to a pension kicking in, if your health changes, if you realize you’re bored and want to go back to work, if you decide that you’re going to buy a new motorcycle, etc. Having assets in both your RRSP and TFSA throughout these periods not only helps provide income, it can also help you smooth your taxable income and maximize the tax benefits of these two accounts.
TFSA TOP UPS
Make sure that your TFSA is maximized at the 2019 limit of $63,500 (that’s another $6,000 in room you’ve earned this year as of Jan 1st).
RRSP CONTRIBUTIONS
This year, you have until Friday, March 1st, 2019 to make your 2018 RRSP contribution.
This year, you have until Friday, March 1st, 2019 to make your 2018 RRSP contribution.
Contributing early means avoiding the last minute rush but it can also boost your RRSP’s growth over time because your assets will have more time to benefit from tax-deferred compound growth (compounding is the 8th wonder of the world).
Determining Your Available Contribution Room for 2018
1. Start with 18% of your 2017 earned income or $26,230 (whichever is less).
2. Subtract any Pension Adjustment appearing on your 2017 T4 tax slip.
3. Subtract any contributions you’ve already made in 2018 (i.e. lump sums and pre-authorized regular contributions – I have these numbers for you)
4. Add any unused RRSP contribution room carried forward from previous years.
OR you can simply check your latest Notice of Assessment, Notice of Reassessment or RRSP Deduction Limit Statement (Form T1028), or log on to your Canada Revenue Agency account at www.cra-arc.gc.ca/myaccount to confirm for sure.
If you’re already ahead of schedule, note that you can also make your 2019 contribution any time now (until March 1, 2020) to benefit from additional tax-deferred compounding. The contribution limit rises to $26,500 for 2019.
Now you are in-the-know with Word on the Street.
Enjoy the weekend.
D.
Dian Chaaban
Investment & Wealth Advisor
Chaaban Wealth Management Group
416.842.4234