Sunday, February 17, 2013

My Rule of Thumb for RRSP vs TFSA

Much has been written on whether the RRSP or TFSA is the better savings vehicle. The RRSP reduces your taxable income in the contribution year, which in turn reduces your tax burden. The benefits are felt immediately but funds are taxed when you withdraw from the RRSP in the future.  The money that you can contribute to a TFSA does not impact the current tax return, but is tax-free upon withdrawal.

Obviously those with enough money would max out on both, since they each have their strengths.  For everyone else, the question of which is the better choice?  Common wisdom has been that those in a higher income bracket should lean towards the RRSP, while the lower income bracket should go for the TFSA.  The former require the RRSP contribution to reduce the amount of income tax they need to pay.  The latter don't pay much income tax anyways and want to keep their income low in the years when they withdraw from their savings vehicle, in order not to trigger government pension clawbacks. (e.g. Old age security)

I've always used a more generic rule of thumb, that could apply to any income bracket:
  1. Contribute to the RRSP up to the point where you don't have to pay tax anymore.  You can use various online tax calculators, as listed in my book Retired at 48, to estimate how much this would be. 
  2. With any spare money, contribute to the TFSA until you max out. The sooner you start contributing to a TFSA, the more that money can experience compound growth tax-free. 
  3. If there is still spare money, then increase the RRSP contribution so that you actually get a refund back.  

No comments:

Post a Comment