TFSA or RRSP? If you are going to have a lower tax rate when you retire, it’s generally better to opt for an RRSP. (Shutterstock/Khongtham)
It’s RRSP season—those first 60 days of every year when financially savvy Canadians tend to top up their registered retirement savings plans, in anticipation of claiming a tax deduction on their previous year’s return.
But myths about RRSPs abound, confusing consumers about whether there is any point in contributing. That’s why we have rounded up some of the most persistent tales in order to put them to rest once and for all.
Myth No. 1: It’s pointless to invest in an RRSP, because you will have to pay your savings back in taxes when you retire
Popular as this myth might be, it’s inaccurate, says Jamie Golombek, CPA, CA, managing director of tax and estate planning with CIBC Financial Planning and Advice, in a 2018 CIBC report. “Although you do pay tax on RRSP withdrawals, don’t forget that you also got a tax deduction upon contribution.”
And if your tax rate is the same in the year you made the contribution as it is in the year you make the withdrawal, an RRSP will give you a completely tax-free rate of return. Golombek adds that if your tax rate is lower in the year you withdraw the money, you’ll get an even better after-tax return rate.
Myth No. 2: It's better to go for a TFSA than an RRSP
In a January 2018 poll conducted by CIBC, 67 per cent of Canadians said they think TFSAs are better tax-saving vehicles than RRSPs because they are completely tax-free. But the picture is more complicated than that. With TFSAs, your contributions are not tax deductible as they are with an RRSP; but when you withdraw your money, you won’t have to pay tax on it, as you will with an RRSP. For this reason, it has been said that TFSAs and RRSPs are mirror images of each other.
But what does this mean in terms of saving? If you are going to have a lower tax rate when you retire, it’s generally better to opt for an RRSP, says Golombek. But if you are expecting to have a higher tax rate, you might be better off with a TFSA.
Faisal Butt, an investment adviser with Edward Jones, agrees. “If you have a rich pension plan, if you’re planning on working in retirement or if you have other sources of income, you might want to look at a TFSA or other savings options,” he explains. However, Butt also says there’s room for both types of vehicles in any well-built plan.
Myth No. 3: It’s better to pay off debt
There can be some truth to this myth in certain situations: for example, experts agree that it usually makes sense to pay off high-interest debt, such as credit card balances, before turning to RRSPs. But for other kinds of debt, including mortgages, you need to look at your own financial picture and other factors before making any decisions. Often, there can be a tipping point for contributing to an RRSP.
“It all comes down to opportunity cost,” says Matthew Ardrey, wealth adviser and vice-president of Toronto-based TriDelta Financial, in an article by Jonathan Chevreau, founder of the Financial Independence Hub. “If you can earn better returns in your retirement savings than what your mortgage is costing you, then it makes more sense to allocate your funds there.”
As Butt points out, however, it’s important to remember that the debt-versus-RRSP decision does not have to be either-or; for most people, the best scenario is to do both.
Myth No. 4: I don’t have enough money to save in an RRSP
In the CIBC poll, the main reason given for not contributing to an RRSP—especially among 35-to-54-year-olds—was a lack of funds. But the reality is, you don’t need a lot of money to start saving. As Golombek points out, relatively small contributions on a regular basis can really add up.
“Suppose you were to invest just $100 each month in an RRSP from ages 30 to 65 and could obtain a rate of return of 5 per cent on your investments,” he says. “In 35 years, you would build up over $114,000 in your RRSP to use for your retirement.”
According to experts, finding the money to save isn’t as hard as it may seem, either. As Butt explains, it’s a matter of putting funds aside before they are used for other purposes. “This technique, often called ‘paying yourself first,’ is a simple and painless way to boost savings,” he says. For example, you can set up an automatic savings plan and/or invest through workplace payroll deductions. “If your employer makes matching contributions or contributes to your group RRSP on your behalf, take advantage of it as it is essentially free money,” he says.
Myth No. 5: If I save too much in an RRSP or RRIF, I will leave behind a large tax bill when I die
As Golombek explains, tax rules require that the fair market value of your RRSP or Registered Retirement Income Fund (RRIF) as at the date of your death be included as income for that year, with tax payable at your marginal tax rate for the year. But he adds that there are exceptions that may allow for a tax-free rollover to certain beneficiaries.
There are also a number of other strategies that can help reduce the size of your estate at death. As Butt explains, “An effective wealth transfer strategy can help you accomplish a variety of goals, such as distributing your assets the way you choose, avoiding probate fees and reducing estate taxes. Possible tools include: gifting to adult children, permanent life insurance, trusts and beneficiary designations.”
But whichever tax strategies you want to explore, you shouldn’t wait too long to get started, he says. “Time has a way of sneaking up on all of us—but it’s especially sneaky when we’re unprepared.”
WANT TO LEARN MORE ABOUT RETIREMENT SAVING?
CPA Canada has a number of resources that can help, including financial planning, understanding RRSPs and TFSAs and The Procrastinator’s Guide to Retirement. To plan a financial literacy session in your community, see Planning for retirement.