by Rick Sutherland, CLU, CFP, FDS, R.F.P

Well it’s here, the annual hustle and bustle of the “RRSP Season.” Most Canadians know the value of contributing to their Registered Retirement Savings Plan (RRSP) and many have also contributed to their Tax Free Savings Account (TFSA). With tighter economic times and limited cash available for savings, we are frequently asked which is a better vehicle for long-term saving, the RRSP or the TFSA.

The short answer is that they are almost identical from a tax point of view. In the interest of not losing anyone in the numbers, we will attempt to walk you through the math. Three simple examples will show you how an individual’s personal tax rate at the time of contribution and at the time of withdrawal will determine which is better.

In our first example we will assume a 40% tax rate and a compound growth rate of 7.18% for 10 years. We use this return to keep the numbers simple. Money doubles in 10 years at this rate of return.

First let’s look at the TFSA. If you earn $1,000 gross income you will have $600 net to invest. Your $600 will grow to $1,200 at the end of 10 years. That $1,200 is yours to withdraw and spend with no tax owing. Now let’s look at the RRSP option. Since the RRSP is tax deductible, the full $1,000 is available to be invested. It will be worth $2,000 in 10 years. However you must pay the tax when you withdraw from your RRSP. Assuming a tax rate of 40% you will have $1,200 after tax to spend. In this example both are equal.

But is that a realistic example? Will you be in the same tax bracket when you make your contributions as when you withdraw the money from either program? If we assume a tax rate of 40% when contributions are made and 20% when withdrawals occur, the RRSP will have a clear advantage. Because the TFSA has no tax impact when withdrawals are made, you will have the same $1,200 available at the end of 10 years. However, if you are in a lower tax bracket when withdrawals are made from the RRSP there will be an increased value. Using the same example above and assuming that you are in a 20% tax bracket when you withdraw from your RRSP, you will have $1,600 available to spend, a $400 advantage over the TFSA.

The reverse of this example is that you will be in a higher tax bracket when you make your withdrawals. If you assume a 20% tax bracket at the time of your TFSA contribution, you will have $800 to invest, which will grow to $1,600 at the end of 10 years. The RRSP will still have a value of $2,000; however, if we assume a higher tax bracket of 40% at the time of withdrawal then the amount available to spend from your RRSP will be $1,200. In this example the TFSA has come out the winner by $400.

So as with most important financial decisions, you must do some planning to decide which program will meet your needs and be most beneficial from a tax point of view. Consult with your trusted financial advisor before making decisions.

The foregoing is for general information purposes and is the opinion of the writer. This information is not intended to provide personal advice including, without limitation, investment, financial, legal, accounting or tax advice. Please call or write to Rick Sutherland CLU, CFP, FDS, R.F.P., to discuss your particular circumstances or suggest a topic for future articles at 613-798-2421 or E-mail rick@invested-interest.ca. Mutual Funds provided through FundEX Investments Inc.

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