3 REASONS
WHY RRSPS STILL MATTER, DESPITE THE RISE OF TFSAS.
Until 10 years ago, the Registered Retirement Savings Plan (RRSP) was the only game in town when it came to tax-assisted retirement savings. The combination of an upfront tax deduction on contributions plus ongoing tax-sheltered growth of the underlying investments made it almost a no-brainer to maximize yearly contributions.
With a looming March 1 deadline for RRSP contributions to defray income taxes for calendar 2018, not to mention the tax-filing crunch looming on April 30, some pundits question whether the RRSP’s time in the sun has passed.
At least for young people in lower tax brackets, they say the RRSP argument has become less compelling since Tax-Free Savings Accounts (TFSAs) were launched in 2009.
Even so, there are at least three good reasons for continuing to use RRSPs, especially if you’re a higherincome earner in or near the top tax brackets. If so, you should maximize your annual RRSPs contributions every year you’re earning the big bucks. And if you’re making that kind of money, you can afford to contribute to TFSAs as well.
The enthusiasm for TFSAs tends to be accompanied by the critique that RRSP tax savings will eventually have to be paid back to Ottawa once the plan morphs into a Registered Retirement Income Fund (RRIF), or is cashed out or annuitized. This must happen at the end of the year you turn 71. At that point, RRIFs are subject to forced annual withdrawals that are taxed, and the withdrawal rate rises with age.
Like RRSPs, TFSAs provide ongoing tax-sheltering of investment income. But unlike TFSAs, RRSPs still provide that tax deduction, one often accompanied by a juicy tax refund in the spring. TFSAs don’t, although they will shine in retirement because their withdrawals won’t be taxed, which means they won’t trigger OAS (or even GIS) clawbacks.
Matthew Ardrey, vicepresident of Toronto-based TriDelta Financial, remains convinced that for higherincome Canadians, the RRSP “is better than the TFSA for retirement savings.” Odds are you’ll be in a higher tax bracket when employed than in retirement or semi-retirement. “There is a clear advantage of receiving the deduction at a higher marginal tax rate and paying tax in retirement at a lower marginal tax rate,” Ardrey says.
Over the long run, “the power of tax-deferred compounding really delivers,” says Adrian Mastracci, portfolio manager with Vancouver-based Lycos Asset Management. It’s not that unusual for older families to have $1.5 million to $2 million in RRSPs, says Mastracci.
Financial planner Aaron Hector, vice-president of Calgary-based Doherty Bryant Financial Strategists, agrees TFSAs are better for young people in low tax brackets but notes the decision must be based on effective tax rates, not just marginal tax rates. The “effective” tax rate should factor in not just federal and provincial taxes but also clawbacks of government freebies like the Canada Child Benefit (CCB.) By lowering your taxable income, an RRSP contribution can minimize CCB clawbacks. Hector tells young couples planning on having children to first invest in TFSAs with the plan of eventually transferring that money into RRSPs and RESPs. Once the kids arrive they can receive the CCB and Canada Education Savings Grants.
But there are at least two other advantages RRSPs have: Despite its name they’re not just for retirement; they can also help you go on to higher education or save up a down payment for a first home. You can withdraw up to $20,000 for the Lifelong Learning Plan, and up to $25,000 for the Home Buyer’s Plan ($50,000 for couples). You do however have to repay at some point.
And there’s a third advantage RRSPs have over TFSAs, one that’s relatively unknown according to Ardrey: RRSPs are much more tax-efficient when holding U.S. or foreign dividends or interest. That’s because TFSAs aren’t recognized as tax-sheltered accounts by foreign nations, so you will be charged 15 per cent withholding tax on, for example, U.S. dividends if those securities are held in TFSAs but not if they’re in RRSPs.
In the end, it’s not an “either/or” question of RRSP or TFSA. If you’re a highincome earner, you should probably do both.
Hector says it’s important to have “balance” in retirement accounts. If all your savings are only in an RRSP, large one-time cash withdrawal requirements can get expensive. But someone with a combination of TFSA, RRSP and non-registered accounts can instead pull lumpy payments (for a new car or home renovation, for example) from non-taxable accounts.
Finally, remember there’s a lot more contribution room for RRSPs. The new maximum annual contribution for TFSAs is $6,000, compared to $26,230 for RRSPs in calendar 2018, assuming you earn $145,700 and have no Pension Adjustment from corporate pensions. That’s up from $26,010 in 2017, and the limit rises to $26,500 in 2019 and to $27,230 in the 2020 tax year, says Mastracci.
RRSPs ARE MUCH MORE TAX-EFFICIENT WHEN HOLDING U.S. OR FOREIGN DIVIDENDS OR INTEREST. THAT’S BECAUSE TFSAs AREN’T RECOGNIZED AS TAX-SHELTERED ACCOUNTS BY FOREIGN NATIONS. — JONATHAN CHEVREAU, FINANCIAL INDEPENDENCE HUB