Investors in the RRSP or RRIF drawdown stage of their life (over age of 71) are now paying taxes on their withdrawals. They then compare this to a TFSA which allows for tax-free withdrawals and start to question whether it was worth contributing to the RRSP in the first place.
This comparison can be framed in many ways, but the short answer is: assuming equal tax brackets on the way in and the way out, an investor will have the same net cash balance in both accounts:
Source: Jamie Golombek
A TFSA contribution is made with after-tax dollars. The RRSP, once you factor in the refund or tax savings, allows for a pre-tax contribution of income.
What if the tax brackets are different when you withdraw funds? If you anticipate a higher tax bracket at retirement, the argument tilts in favour of the TFSA. If you anticipate a lower tax bracket at retirement, you are better off with the RRSP.
So the answer, as with most debates, is it depends. Based on what we see in our office, tax rates are usually lower at retirement. Most working Canadians are in a 30% marginal tax bracket, which has an income range of about $44,000 – $75,000. Most retirees have income lower than $44,000, which is taxed at 23% or lower.
A very basic rule of thumb is that if you’re in at least the 30% tax bracket, the RRSP is likely a safe bet.
There are other issues to consider as well (What if I don’t invest my refund? Potential claw back of retirement benefits). These will be addressed in a future article.
Jamie Golombek, a well-respected source on the taxation side of financial planning, goes into this in far more detail. If you want to read his full comparison of the RRSP and TFSA, click here: