A Little Strategy Goes a Long Way

Have you ever thought to yourself something along the lines of, “I want to start investing for my future, but I’m not sure what type of account is best…” or “I already have an RRSP so I don’t think I need a TFSA”? Well, you’re not alone. As of January 2020, approximately 1 in 4 Canadians didn’t know the difference between TFSAs and RRSPs.[1]

Confusion about TFSAs lingers in Canada, despite more and more Canadians reportedly having an account. Of the 15 million Canadians with a TFSA, 8.5 million of them contributed to their TFSAs in 2018, a 2021 Financial Post article found, but only 1.4 million people maxed out their contribution.

Many people default to RRSPs, in part, because of their longstanding popularity but also because of the enticing refund following tax season. Others – especially young folks – may want to open an RRSP because they’ve been told it’s the responsible thing to do. What they may not realize though is it might not be the best option for them because of where they’re currently at in their career.

Whether or not a TFSA or RRSP is right for someone depends heavily on their current income and marginal tax bracket. To put it simply, the reason has to do with avoiding the kind of “tax leakage” that occurs when money is contributed at a lower marginal tax rate and later withdrawn at a higher one.

Remember, there are no tax consequences when withdrawing from a TFSA like there are when withdrawing from an RRSP. A strategic way to make the most of both a TFSA and RRSP can be to begin saving in a TFSA while in a lower tax bracket and then roll those savings over into an RRSP when you enter a higher tax bracket. This way, you can begin saving for retirement early while also avoiding tax leakage.

It’s not just young people though, who should seriously consider the benefits of a TFSA. Unlike RRSPs which have an age contribution limit of 71, TFSAs have no age limits. This makes them ideal savings accounts for seniors looking for ways to continue sheltering their investments from taxes while in retirement.

As we approach tax season, now is a good time of year to revisit your financial plan, make any necessary updates and ask your advisor how to make the most of any potential tax refund you receive.

For some, the promise of a refund makes tax season seem almost exiting. For others who find themselves owing money to CRA, not so much. But just because you have a tax debit doesn’t mean you can’t also save money for the future. Rather than paying your debt outright, consider offsetting it by rolling over TFSA savings into an RRSP (if you’re eligible to buy one) and then using the resulting credit as part or all of what you have to pay CRA.

Many people also find tax season stressful because they feel torn between different competing priorities. A common scenario is whether to contribute to an RRSP or make additional payments to a mortgage. If you’re in a situation where you don’t owe any tax debt come tax season, you might be able to do both.

For those in average to higher income tax brackets, let’s say 40% for the purposes of this example, contributing $10,000 to an RRSP would generate a $4,000 tax return. While this money could handily be stashed away in a TFSA for shorter term savings, the option to put it towards your mortgage principal, also exists. With this strategy, you take care of your future self in a way that is doubly beneficial, rather than in a way that may actually be less helpful than it seems. For an in-depth look at why contributing extra to your mortgage principal instead of an RRSP can cause you to lose out on savings in the long run, click here.

A persisting misconception among Canadians is this idea of needing to pick a retirement savings vehicle and stick with it forever. Conversely, some understand both accounts can be useful for different savings goals but do not know the specifics and more importantly, when to use them. To ensure you’re making the most of your retirement savings opportunities this tax season, connect with us.

[1] https://www.bnnbloomberg.ca/1-in-4-canadians-don-t-know-the-difference-between-a-tfsa-and-an-rrsp-survey-1.1380298#:~:text=Thirty%2Dfive%20per%20cent%20of,on%20behalf%20of%20the%20bank.