RRSP and TFSA Strategies You Can Take to the Bank

rrsp_tfsa_nest_eggIt’s that time of the year again – RRSP Season. Canadians will be lining up at the bank to either contribute to their RRSP (Registered Retirement Savings Plan), or borrowing for an RRSP loan. For most Canadians, that net benefit will be a tax-refund. What many Canadians don’t realize however, is the refund from contributing to their RRSP is not a gift. It has to be paid back later with taxes. That’s because any money withdrawn from your RRSP is considered income and is fully taxable. This makes the RRSP nothing more than a tax-deferral plan.

Any money withdrawn from your RRSP (or RRIF) is considered income and is fully taxable. This makes the RRSP nothing more than a tax-deferral plan. 

Many high-income Canadians can get a net-benefit from contributing to their RRSP, especially if it places them in a lower tax bracket. However for most Canadians, maximizing their TFSA (Tax Free Savings Account) makes more sense. The key is to avoid looking at the short-term refund, and treat your TFSA and RRSP as an overall financial plan. If you can’t contribute to both, then which one makes the most sense for you? In most cases the TFSA will be the clear winner.

RRSP Income in Retirement

Before January 1st 2009, the TFSA wasn’t even a consideration. The RRSP was the only game in town for Canadians to shelter investment income and reduce taxes. For those with modest incomes, the RRSP was a chance to be able to save for retirement, and get the benefit of a tax refund. For high income earners, the RRSP presented an opportunity to lower their tax rate through contributions. Most Canadians, regardless of income, viewed withdrawing from their RRSP (or RRIF) as something they could worry about later in retirement.

There was also an adage in the financial planning industry, that it was OK to maximize your RRSP, because in retirement you would be in a lower tax bracket. To a degree that is true. However, many Canadians who earn a high income also tend to have a pension plan through their employer. As with RRSP withdrawals, these Registered Pension Plan (RPP) withdrawals are also considered income, and are fully taxable when withdrawn. Including government benefits, private or public pensions, as well as investment income could provide for a significant income.

Contributing to your RRSP now, might in fact be an extra tax burden in retirement. Remember, you will be taxed on all those future years of income and compound growth of that RRSP contribution, not just the initial amount.

Here are three RRSP and TFSA strategies you can take to the bank, which will help you pay less tax in retirement:

Optimize Your RRSP

Optimizing your RRSP is a strategy I first came across at myownadvisor.ca, although the strategy has been around for a long time. Mark discussed the idea of only contributing enough to your RRSP to offset any additional taxes payable. His post was titled, Why we optimize, do not maximize our RRSPs.

The first thing to do is determine if you actually have any tax payable. Downloading software such as TurboTax, allows you to quickly asses all your tax receipts, and check if you have any tax owing. You can then test various contributions with the software, to see how much you actually need to contribute – if any. Optimizing your RRSP means only contributing what you need in order to offset taxes payable.

Maximize Your Refund

Another strategy is to maximize your refund with a small RRSP Loan. The Passive Income Earner recently discussed this strategy in, Weekly blog round: RRSP Planning (although he called it optimizing). Again you’ll want to download some tax software so you can play around with the numbers.

The idea is to basically borrow the amount of your refund for an RRSP loan, thereby increasing your RRSP contribution. Then most importantly, use the entire refund to pay down your short-term RRSP loan. For example, if you have a $1000 refund and you are in a 40% tax bracket, then borrowing an extra $1500 will result in an additional $600 towards your tax refund. Your total refund now comes to around $1600 and will pay off the short-term RRSP loan. You’ve also managed to contribute an additional $1500 towards your retirement – although you’ll also pay tax on it later.

This is a much better route than taking out an RRSP loan for an extended period of time, and paying additional loan interest. The idea is to make a short-term RRSP loan, boost the tax refund, and pay back the loan as quickly as possible.

Maximize Your TFSA

The TFSA is the ideal retirement vehicle, because there are no taxes payable when money is withdrawn. Your investments and income also benefit from tax-free growth.

One strategy is simply not to contribute to your RRSP at all and maximize your TFSA. This allows you to build up a small retirement nest-egg, without having to pay tax on future withdrawals. If you are not expecting much of a refund in the first place and don’t need to optimize your RRSP, then this might be the better route to go.

I have a pretty simplistic view of the TFSA, and I think everyone should contribute, regardless of income. As I wrote two years ago in January 2011, Max Out Your TFSA, and Forget the RRSP!  The concept is pretty simple. Although you don’t get a refund for contributing to the TFSA, you don’t have to pay any taxes when you later make withdrawals. As well, all the income and gains in your TFSA compound tax-free.

For 2013, you are allowed to contribute a maximum of $25,500 to your TFSA. That’s $5,000 per year from 2009 to 2012, and $5,500 for 2013. I think everyone should contribute and max out their TFSA regardless of their income. For most Canadians maximizing 5K per year will be a struggle, and for some Canadians the 25K will be a nominal investment. However each year, the allowable room is increasing by $5,500. Sadly, according to Garth Turner in his recent post, the gift, only 4 in 10 Canadians even have a TFSA. Garth writes,

Despite being able to shelter all this money from any kind of tax, most don’t. Only four in ten people have a TFSA, even five years after it was created. Of those only half actually contribute to them.

Readers what’s your take? Are you investing in the TFSA, RRSP, or both? What’s Your RRSP strategy for 2013?

Disclaimer: Tax and investment planning is beyond the scope of this blog, nor am I a certified financial planner. I suggest everyone at some point should sit down with a certified financial planner, their accountant, or estate and tax expert, and make a long term financial plan. The TFSA and RRSP are only part of the plan. ;)

31 Responses to “RRSP and TFSA Strategies You Can Take to the Bank”

  1. Good post! I do both and you are right, I should call it maximizing instead of optimizing but I wanted to differentiate between re-investing your refund which truly maximizes your investment versus borrowing to make an even greater contribution up front since you get to take the immediate tax refund from the borrowed money.

    A thought occured to me that if as a couple you only had TFSA, at the point of retirement, you would have $0 income from the government perspective, does that mean you can get CPP, OAS and GIS ? It’s like you can find a way to get access to GIS even though you have money …

    • The Dividend Ninja

      Jan 31. 2013

      PIE, currently I believe there would be no clawbacks since TFSA withdrawals are not considered income – unlike RRSP or RRIF income. This is a BIG advantage for the TFSA. Jim Yih points to the same conclusion:

      http://retirehappy.ca/minimizing-old-age-security-clawback/

      Let’s hope the government keeps it that way. ;)

      Cheers!

      • Thanks for the post on OAS from Jim.

        It’s funny how we all work around the taxes … and the government follows behind to close the loop holes as they are discovered.

        You can definitely build an amazing nest egg just inside a TFSA – for anyone saving more, everything else creates income though.

        It was interesting to read about withdrawing RRSP before 65 … If income is lower, it might be more beneficial to do that and move it to dividend income … Except they use the gross up for dividend rather than the effective tax for OAS benefits.

        I am so far from thinking about that though :)

  2. Jason St-H

    Jan 31. 2013

    My TFSA is the first thing I maximize. As for my RRSP, I go with a “Contribute now, deduct later” approach because I just finished grad school (lots of tax deductions!) and I’ll be in my highest tax bracket in just a few years.

    • The Dividend Ninja

      Jan 31. 2013

      Jason, sounds good! Many Canadians can’t afford to max out their TFSA. :)

      I will also carry my RRSP contributions forward this year. Just remember you will pay taxes on all your RRSP contributions later when its withdrawn. That amount will be much greater than your original contribution. But hey, I think you are doing it exactly right!

      Cheers

      • Jason St-H

        Feb 01. 2013

        Thanks! :)

        I might have to meet a tax expert on this one, but I’m lucky enough to be on a governement pension plan so I still haven’t decided if I should skip the RRSP altogether… Growth may be tax-sheltered, but the withdrawals won’t be.

  3. Vicky

    Jan 31. 2013

    I am definitely a TFSA girl, and would max that out before making RRSP contributions if the decision came down to that. That being said, I personally have both TFSA and RRSPs maxed out at the moment.

    The GIS question is a very interesting question though, as its requirements is based solely on income. Assuming that the program is still around when we retire, do you think they would have to adjust the rules? If you have an employer pension plan, you wouldn’t be eligible anyways, but if you didn’t have that or RRSPs, but a maxed out TFSA? That could prove very beneficial for some.

    • The Dividend Ninja

      Jan 31. 2013

      Hi Vicky,

      That’s great that you are in the position of being able to max-out both your TFSA and RRSP! Congratulations on achieving that goal (even if you are an index investor – joke! LOL).

      Hey have you considered adding dividend stocks now, or similar ETF, as non-registered investments so you can take advanatge of the dividend tax credit? :)

      See my comment above to PIE. As you know, TFSA withdrawals are currently not considered income. This is definitely a huge benefit. Lets hope the Federal Government keeps it that way. ;)

      Cheers

      • Vicky

        Jan 31. 2013

        It is almost too good to be true! You know the government will mess that up! :P

        I am currently holding XIC in my non-registered account at the moment. When I have more money to invest, I MAY consider adding some dividend stocks to it. :)

        • The Dividend Ninja

          Jan 31. 2013

          Hey Vicky, yes they will mess it up won’t they. Darn!

          The reason is becuase you will get a higher yield. XIC currently has a dividend yield of only 2.49%.

          You can get a yield of 4%+ by owning dividend stocks directly plus the increase in share price. You are already diversified, but you could certainly sell some XIC and/or with new money buy some dividend payers. You would really be able to increase your yield. Just sayin. :)

          PS
          Not that I would ever time the markets, ha! ha! but I’d wait for the sell in May :)

          • Vicky

            Feb 01. 2013

            May, hey? I’ll keep that in mind. Why May? :P

            I told myself that if I can remain an index investor for a couple of years, then hopefully I would have my gambling tick under control before I start jumping on to individual stocks again. It was a complete disaster when I did it before!

            • The Dividend Ninja

              Feb 02. 2013

              How about a $10 bet markets sell off in May? just for fun, and I’ll even pay the postage on the envelope if I lose. :)

              I’ve got a few posts coming down the pike on choosing dividend stocks – stay tuned.

              Cheers

              • Vicky

                Feb 05. 2013

                No, I can’t gamble! Once I start, it will just lead to me spending all my days at casinos! :P

                You will have to remind me if/when you are right in May. You can have bragging rights; how about that?

  4. My Own Advisor

    Jan 31. 2013

    Great post!

    Thanks for the mention!

    Definitely a TFSA guy. That account is a gift to everyone, whether you can put $5, $500 or $5,500 into it this year.

    I’ve got my TFSA maxed out…we need to work on the other one now.

    For a low-income earner, I don’t think an RRSP loan makes any sense. They should avoid that. That strategy is only good for a high-income earner IMO.

    Again, great work here helping folks out.

    Mark

    • Just for the sake of educating others :)

      Is it the loan that you don’t recommend or the strategy of adding more to the RRSP through a loan? (Since the tax benefit is minimal at a low income) I also think a RRSP loan has a lot of negative since Banks are trying to take advantage of that but using a line of credit for 2 months until you receive your tax refund to pay it is perfectly fine in my opinion.

      • The Dividend Ninja

        Jan 31. 2013

        I think taking out a short-term RRSP loan or using a low rate LOC, and then paying down the full amount of the loan with the refund is perfectly acceptable. :)

        For many people, I believe they are unaware of the benefits of the TFSA, especially with a lower or modest income.

        The real key here is to remember the RRSP contribution, will compound over the years, and that amount will be fully taxable at retirment – at your full tax rate.

        Cheers

    • The Dividend Ninja

      Jan 31. 2013

      MOA Thanx for dropping by!

      Maxing out your TFSA as well as your wife’s TFSA now is a great idea. You’ll be set with a nice nest egg that won’t be taxable in retirement. Sounds like a winning plan to me. :)

      Cheers

  5. Syd

    Feb 01. 2013

    Ninja,

    I’m fortunate to be able to max both TFSAs and RRSPs each year. I don’t have a pension , but my wife does, so the debate each year is if we should also be contributing to her rrsp. I’ve generally avoided this as I don’t want an excess tax burden at retirement, and instead use the tax refund and any extra funds to pay down the mortgage. But now that my mortgage is fixed for 5 years at 2.94%, I feel like I should carry the debt and instead either contribute to the wifes rrsp or start putting my non rrsp trading account to some use with some index funds or dividend stocks.

    Is there a calculator out there somewhere that allows me to enter the present and/or future value of my wife’s pension and help me determine the amount I should be contributing to reach the target income level at retirement?

    I read somewhere recently that is your debt is 3 percentage points or higher than your expected returns, you should pay debt. In my case im paying less than 3% in debt so by that logic I should be investing as much as possible vs paying the mortgage down early. Do you have any guidance here?

    great post… Keep up the awesome work.

    • The Dividend Ninja

      Feb 01. 2013

      Hi Syd,

      That’s great you can max out both! :) I’m certainly not a financial planner, and it sounds like you are in a great position to take the next step. I’ve always looked at the mortgage as an investment, since you are buying into equity. Its defintely debt when you have monthly mortgage payments though! If you are in a comfortable position to pay down the mortgage and invest, then I would certainly consider it.

      Regarding the pension, my pension plan gives me a statement each year that tells me the monthly income I can expect at different ages. What they won’t tell me is the “value” of the plan, unless I was to quit employment and convert it into a LIRA (locked in retirement account). Pensions are very complex. But if your wife has the defined pension as I do, then it’s worth gold.

      Sounds like you really need to sit down with a certified financial planner (not a mutual fund dealer) and work out some numbers. I’d recommend you get in touch with Jim Yih as he is a fee only advisor, and specializes in these types of issues:

      http://retirehappy.ca/

      Cheers

  6. farcodev

    Feb 01. 2013

    Great post DN!

    My TFSA is my main investing account for now, I’ll open a non registered account this year in addition of the TFSA.

    TFSA is a godsend on tax purposes, RRSP is out of the way for me since I plan to retire well before 60 years old.

    • The Dividend Ninja

      Feb 01. 2013

      Farcodev, sounds like a good plan!

      Although you won’t get the benefit of the tax-refund, you will have a nice non-taxable nest egg when you retire with the TFSA. You’ll be able to withdraw the money tax-free with a smile on your face. :)

      Cheers

      • farcodev

        Feb 05. 2013

        Haha exactly DN!

        Even if after this year the most part will be on the non reg account, the TFSA will reduce greatly the tax burden, and the non reg will be only for very long term dividend stocks.

    • Brian So

      Feb 01. 2013

      Farcodev, if you plan to retire before 60, then you can contribute to your RRSP now to get a tax deduction and then take money from it from the beginning of retirement to age 65, before GIS and OAS starts, so you don’t risk their clawback.

      Taxable income now: employment income
      Taxable income from retirement to 65: RRSP withdrawals
      Taxable income from 65 onwards: CPP

      • The Dividend Ninja

        Feb 02. 2013

        Hey Brian, but why put money into the RRSP if you know you just have to pay taxes on it later?

        I think what FarcoDev is saying is that he is trying to max out his TFSA contributions first. Then he call take it ALL out TAX FREE. :) Once he does that then he can look into the other options, such as RRSP etc.

        Cheers

      • farcodev

        Feb 05. 2013

        Brian, I’m not very hot on the RRSP, and as DN said, I don’t want to pay taxes on my accumulated capital + returns at 65/67.

        Even if divy taxes are applied on non reg accounts, you can always do the gross up calculation and reduce them more or less. The second thing is that I’m not bended by the government rules when I’ll want to cash in part of my capital, I find the rules really horrid and don’t need that when I’ll have this age.
        I know there’s taxes on capital gain, but hey there’s always something in the world that can reduce them ;)

        RRSP has perhaps advantages but you stay chained to the government rules and personally if I want to be job free between 49-53 y.o. it’s not to have something locked by the gvt after that. Also we never now how will be the situation of our federal and provincial government at this period, I don’t count on government benefits to live my old days, especially when I see the debt levels of them actually.

        Just a personal choice.

  7. Bet Crooks

    Feb 02. 2013

    We top up the RESPs first (hard to beat a guaranteed 20% return on investment)(that’s the matching government grant for anyone who isn’t clear). Then we top up our TFSAs. Then we decide how much should go into an RRSP and for whom.

    I have serious doubts that the government will keep the TFSA, OAS, GIS rules the way they are today. However, for now the TFSA is the optimum place for most of us to invest.

    • The Dividend Ninja

      Feb 02. 2013

      Hi Bet,

      Let’s hope not, but for now the TFSA is a sweet deal (and the RESP too). :)

      Cheers

  8. Diane

    Feb 27. 2013

    Quick question: 61 yrs. old, no company pension, about $225 K in RRSP. I am currently working and earning about $40K annually. When I retire (later this year), my annual income will be around 25K . While my actual income is less, my tax bracket stays more or less the same. Which is better for me to contribute to going forward – RRSP (I have room remaining) or TFSA.?

    • Brian So

      Feb 27. 2013

      Hi Diane,

      Generally, it makes more sense to put money in a RRSP when you’re in a higher bracket than when you withdraw from it. The opposite is true with a TFSA. Since you’ll probably be in more or less the same tax bracket when you deposit and withdraw, I’d go with the RRSP so you can at least defer paying taxes on it until you’re 71.

      Hope that helps.

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