As we emerge from the pandemic, get vaccinated and stay healthy, it’s important that our finances remain healthy as well. This monthly series will offer timely, money-saving ideas and strategies from our financial and tax planner (and Graphic Arts Media Advisory Board member), Steven Aprile.
Is it better to contribute to a TFSA or an RRSP?
Tax-free savings accounts (TFSAs) have been around since 2009 – and those of us that are old enough could have contributed $75,500 since then! But is it better to contribute to a TFSA or an RRSP (registered retirement savings plan)? Here’s one scenario.
Moe, Larry and Curly live in Ontario and each makes $110,000. All three of them have $5,659 to invest in a Canadian stock that currently has a dividend yield of 6%. Moe invests the $5,659 in a regular trading account and one year later he has $5,999 less taxes of $86 or $5,913. Larry puts the $5,659 in his TFSA and has $5,999. Curly borrows $4,341, contributes $10,000 to an RSP and gets a tax refund of $4,341 and repays the loan. One year later he has $10,600. He withdraws the $10,600 from his RRSP, pays taxes and has $5,999 left – the same as Larry! So Moe is the worst off.
Larry could end up ahead of Curly, if he gets a big raise and does the RRSP when his marginal rate is higher (48.29%). He takes the $5,999, borrows $4,601 and puts $10,600 in RRSP. His tax refund is $5,119 so he is ahead by $518! Curly could end up ahead of Larry if he can split the RRSP with a lower income spouse, or his tax rate has gone down at the time of withdrawal. So what’s the lesson here? Try your best to predict what the future holds for your specific individual situation so that you can make the best choice that delivers the most profits.
It’s never too early to do some RRSP planning
As we gradually emerge from the pandemic, many of us are still anticipating an uncertain financial future. One of the few issues that we can indeed be certain of, however, is that continued RRSP planning is always time well spent. You have until March 1 of 2022 to contribute to your RRSP and lower your taxes for the year 2021.
Claire and Joe have two children aged 16 and 13 and they live in Ontario. In 2020 Claire’s salary was $110,000 and Joe’s was $40,000. With no RRSP contributions, they’ll receive $1,907 of the Canada Child Benefit (CCB) for the 12 months ended June 30, 2022. If Claire contributes $20,000 to a spousal RRSP, the CCB would increase to $3,047. Claire would get a tax refund of $8,098. Let’s say she had to borrow the $20,000, paid the loan down to $11,902 with her tax refund, and pays interest of 3% for five years and owes $13,826 after five years.
Joe invests the $20,000 wisely for five years and earns the same 3% that Claire is paying on her loan. After 5 years he has $23,185 of spousal RRSP. He withdraws the RRSP and pays taxes of about $6,400 and has $16,785 left. We are assuming he’s still earning the same $40,000 and tax rates have not changed. Claire’s loan is paid off and they still have $2,959, plus they get to enjoy increased CCB of $1,140 in 2021 and 2022. For Claire and Joe, each dollar of their RRSP contribution up to $20,000 increases the tax-free CCB by 5.7%! Conclusion: They should consider making contributions now and withdrawing when they are no longer entitled to the CCB.