Last week I posted an article called “RRSP Investing Is Not For Everyone”. The main focus was addressing the tax liability associated with RRSP investing. I promised I would explain a solution that would dramatically reduce this tax burden….and that’s exactly what I will be talking about today.
Before I get into numbers I would like to make a strong point here. For obvious reasons, I recommend you speak to a professional (your financial advisor) before taking any actions on my comments. Secondly, if you haven’t had this discussion with your F.A. perhaps you should start. You may feel your portfolio is “too small” or you are “too young” to worry about these things…I’m here to tell you that you would be wrong. Time to address these issues is now and for some of you…that time was yesterday.
Let’s work with these numbers:
Current Portfolio Value: $10,000 (RRSP, TFSA, NON-REGISTERED)
Annual Contributions: $5,500
Time Period: 35 years (age 30 to 65)
Rate of Return 7%
Marginal Tax Bracket 38.4% (average tax rate for 35 years)
At the age of 65 the numbers will look like this if you started with $10,000 and invested $5,500 for 35 years:
(Source: Mackenzie Investment Calculators)
RRSP /TFSA /NON-REGISTERED
$867,069/ $920,289 /$493,837
$73,920 (35 years of tax refunds)
If you are earning an income between $41,000 and $75,000 you are in the 38.4% tax bracket. This means this scenario is 100% you. As you can see the RRSP earns a higher gross value (before taxes) when taking into account the 35 years of tax refunds you would have received (higher by $20,700).
In this scenario you have positioned your entire retirement to generate income that is 100% taxable. That means if you take out $10,000 you will NET approximately $6,160 as opposed to the TFSA which would NET $10,000 on a $10,000 withdrawal. If you convert your RRSP into a RRIF at the age of 71 that means you will have to pull out 7.38% of your portfolio. If you didn’t take out a dime between age 65 to 71 and earned 0%, you would have to pull out $69,444. That amount is fully taxable regardless if you need the money or not. Since you are forced to make this withdrawal, (again, even if you don’t need the money) there is a chance that your OAS (Old Age Security) might be fully or partially reduced because through the governments eyes, you’re making too much money to receive these benefits. From an estate preservation point of view, if you are a widow or single with children, your estate will see less than $450,000. With your TFSA, your estate will receive the full amount – $920,289.
Your best option is to maximize your TFSA and take a pass on RRSP investing and its tax refund. I’m sorry…I mean, take a pass on the deferred tax break. If you take into consideration all the benefits of maximizing your TFSA instead of your RRSP, I’m sure you will come up with an obvious observation. “I need to do something about this!”
• Your TFSA will generate tax free retirement income for you.
• Your TFSA will not cause any issues to your OAS or in some cases your GIS (Guaranteed Income Supplement)
• Your TFSA will leave your estate more money
• Your TFSA will last you longer and preserve your capital more efficiently
TFSA …your retirement will thank you.
Coming up next…
If you are like most people, you probably thought RRSP’s was the only option to save for your retirement besides your company pension plan. My next article will focus on individuals who have accumulated at least $250,000 inside their RRSP before the age of 45. These individuals are in the highest tax bracket and are typically contributing between $15,000 to $21,000, each year. With these numbers they are setting themselves up for a massive tax liability. I’ll discuss what can be done in order to reverse this problem.