TFSA or RRSP: Which is better for retirement planning?
Sixty per cent of Canadians feel anxious about coming up with the money for their retirement savings, according to a new Bank of Montreal study.
And, even if they do find the money, they’re not sure whether it should end up in an RRSP or a TFSA.
That’s odd, because other than the amount of money you can put in, they’re pretty much mirror images of each other.
The big difference between an RRSP and a TFSA is the timing of the taxes you’ll eventually pay. Remember: the two plans are designed to produce the same results, assuming you're going to end up with the same tax rate down the road.
But, for many people, that's not going to be the case.
If your marginal tax rate is higher at the time of contribution, an RRSP will be the better choice since it will defer tax to a point in the future when your income, and consequently your marginal tax rate, will be lower.
This is the most likely scenario for many Canadians since those who are currently retired manage, on average, on about 50 to 60 per cent of what they made when they were working.
If the reverse is true and your taxable income actually goes up in retirement, however, a TFSA would make more sense since you’ll be able to spend 100 per cent of those eventual withdrawals without paying any tax.
I’d say that’s less likely, for most people at least.
But a recent C.D. Howe study warns that many “average” Canadians could actually be looking at a higher marginal tax rate when they retire, thanks to the accumulation of things like the Guaranteed Income Supplement, the federal age credit and the GST/HST credit.
So, which plan is better? Well, it depends. And the farther you are from retirement, the more the difficult it is to figure out.
But it’s still worth a try, particularly now that you can put in up to $25,500 ($51,000 for couples) in a TFSA — providing you’ve never had one before.
You’ll have to check the Notice of Assessment you received in 2012 to see how much RRSP room you have to work with.
Here’s the important difference: RRSP contributions are made with pre-tax dollars, and while they generate tax deductions, withdrawals will be taxed as ordinary income. TFSA contributions, however, are made with after-tax dollars, and eventual withdrawals will be tax free.