The decision on whether to invest in RRSPs or TFSAs can be a tricky proposition. Most people don’t have enough money to maximize both contributions. RRSPs allow you to deduct your contribution from your income, which earns a tax refund. The entire amount including interest income is taxable when you take the amount out. Meanwhile the TFSA is the reverse. There are no tax deductions when you make a contribution, but you don’t pay any taxes on interest income when you take the money out either. Below are 5 factors to consider before investing in RRSPs over TFSAs:
1. Tax Bracket
What will your tax bracket be at the time of retirement? Will it be higher than your current tax bracket? If so you’re likely better off with a TFSA.
How likely are you to withdraw your investment? TFSAs are more flexible when it comes to contributions. You can dip into them at any time without tax consequences. Unlike a RRSP there will be no permanent loss of your contribution room. You get the contribution room back the following year.
For someone at the low end of the income spectrum the additional RRSP income could result in a GIS claw back if it pushes your income above the GIS limit. The GIS single person limit is $17,280 or up to $41, 424 for couples. The amounts vary based on marital status and on the retirement benefits of the spouse. In a low income scenario TFSAs are usually better.
Income between $70,954 and $114,845 is subject to an OAS claw back of 15%. Therefore, if your retirement income is $80,954 there would be an OAS claw back of ($80,954-$70,954 = $10,000 x 15% = $1,500). Therefore, your additional RRSP income could put you in a position to have an OAS claw back at retirement. An affluent retirement earner could find TFSAs more beneficial.
The old age tax deduction amount is $6,684 for people with an income of $34,562 less 15 percent of any amount earned above this amount. For example, if someone makes $50,000 including investment income then the Old Age Deduction amount would be $6,684 – [($50,000 – $34,562) x 15%] = $4,368. Similar to the GIS and OAS claw back take into consideration how much Old Age Deduction you will lose when making your investment decision.
In conclusion, the decision on whether to invest in TFSAs or RRSPs needs to be considered carefully on an individual or family basis. The unknown when doing this analysis is the uncertainty of what future tax rates will be when withdrawing RRSPs. If your retirement is 20 or 30 years away tax rates can change significantly over a long period of time, and close monitoring of your investment portfolio is recommended to ensure your investment returns are maximized in response to changes in tax policy.
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