The RRSP deadline looms the end of February, so it’s time to make some decisions about your tax-free savings options.
By Mike Jaczko, BSc. Phm, RPh, CIM®
Ideally, it would be great to maximize contributions to both RRSPs and TFSAs, but in some cases pharmacists can’t afford to do both every year.
We will briefly explore three of the considerations to save for retirement if you have limited funds. Our first consideration relates to your current and anticipated future tax bracket.
Both TFSAs and RRSPs allow your investments to grow in a tax-sheltered environment. With an RRSP, you can deduct your contribution from your income, which will earn you a tax refund. However, the investment money becomes fully taxable at your marginal tax rate (read: highest) when you take it out later on.
Conversely, the TFSA experience is the reverse, namely you do not receive a tax break on contribution, but you do not pay tax on withdrawals either. So when deciding between the two alternatives, your question comes down to when you are prepared to pay the tax person. “Pay me now or pay me later”. Your answer hinges on where you expect your tax rate is heading in the future.
Conventional thinking says that if you are in a higher tax bracket when you put the money in than when you take it out, it’s better to use an RRSP. This notion makes sense given your original RRSP contribution offers you a juicy tax rebate now, and the tax person takes a smaller piece on withdrawal. I always love to make the income tax people my “partner”! However, if you take the money out when you are in a higher tax bracket than you’re in now, it’s better to top up your TFSA first.
Flexibility is another important consideration. For example, you will fare better with a TFSA if you are saving for a family home and may need access to your nest egg. In these cases you can consider using a TFSA as a vehicle to park your money and allow it to build in a tax-free environment. Specifically, dipping into a TFSA never has a tax impact, whereas you may be on the hook to pay a significant amount of tax in the event you need to draw on your RRSP for an emergency while still working.
It’s important to note that you can take out a specified amount from your RRSP without tax consequences for a first-time home purchase or for education, but you will need to repay those amounts based on some rigid timetables or suffer significant tax consequences. (Check your most recent “Notice of Assessment” that you received in the mail last spring to determine your current contribution limit.) In addition, dipping into an RRSP results in a permanent loss of your contribution room, whereas you can place money into and draw money out with the proviso that you wait until the next calendar year.
A third consideration focuses on the fact that you will be forced to convert your RRSP to a RRIF (Registered Retirement Investment Fund) or an annuity by the year you turn 71 and subsequently be required to make annual minimum withdrawals. In contrast, TFSAs come with few strings attached from a withdrawal perspective.
So if you need flexibility and particularly if you might need the money while still working, using a TFSA may be your best bet. However, long-term focus on building a nest egg through an RRSP is also prudent.
Mike Jaczko, a pharmacist by background, is a portfolio manager, partner and member of K. J. Harrison & Partners Inc., a Toronto-based private investment management firm servicing families across Canada.