By Ermos Erotocritou, CFP
Special to the Financial Independence Hub
With the deadline for Registered Retirement Savings Plans quickly approaching, thousands of Canadians will be getting out their cheque books to make their annual RRSP contributions. While saving for the future is always a good thing, the choice between RRSP or the Tax-Free Savings Account (TFSA) is not that simple.
Too many Canadians blindly make RRSP contributions without knowing if they will be better off in the future by making a TFSA contribution instead. Future RRSP withdrawals count as income and could increase your marginal tax rate whereas TFSA withdrawals do not count as income.
Here are five reasons why you should consider investing in your TFSA instead of your RRSP:
1.) If you expect your income to increase significantly in the near future, you should consider investing in your TFSA, then move that money into your RRSP when your marginal tax rate will be higher, thus benefiting from a larger tax refund.
2.) If your income is low, your tax refund may be too small to make it significant enough to offset future tax payments.
3.) If you expect your income to be equal or higher in retirement, you will end up paying more taxes in the end than you would have saved by making the contribution.
4.) If your income is high and you have a pension plan, the odds of experiencing Old Age Security clawbacks in retirement increases. Not only will you pay more taxes in retirement, but you could be losing an additional $6,742 in OAS benefits.
5.) The same principle applies if you have a low income in retirement. RRSP withdrawals could increase your income, affecting whether or not you qualify to receive the Guaranteed Income Supplement (GIS.)
Whether it makes sense to make an RRSP contribution this year or not, don’t make the mistake of entering retirement with all your money in RRSPs. Even if your income is not high enough to trigger OAS clawbacks, it only takes one year where you face a cash crunch and are forced to make a lump sum withdrawal from your RRSP. That year could cost you dearly. Increased taxes and an OAS clawback could set your retirement back significantly, depending on your situation.
Many other factors need to be considered. TFSA contribution limits are lower than RRSP’s. Will you use your RRSP for a down payment on a home or for education purposes? Will you invest your RRSP refund, use it to pay down high-interest debt or spend it on something frivolous?
Consider using RRSP and TFSA
Perhaps the best solution is not RRSP “or” TFSA but rather RSP “and” TFSA. What will your portfolio look like if you invest in an RRSP, then invest the refund in a TFSA? These are questions that we need to ask before we blindly make that RRSP contribution before March 2nd.
For many people, it still makes sense to make an RRSP contribution but I would suggest getting advice from a Certified Financial Planner. A CFP can take your personal situation into consideration and provide personalized advice that will take the guesswork out of everything I mentioned above.
Ermos Erotocritou is a Regional Director with Investors Group Financial Services Inc.
Disclaimer: This is a general source of information only. It is not intended to provide personalized tax, legal or investment advice, and is not intended as a solicitation to purchase securities. Ermos Erotocritou is solely responsible for its content. For more information, please contact an Investors Group Consultant. Insurance products and services distributed through I.G. Insurance Services Inc.