As the March 3 RRSP contribution deadline quickly approaches, some investors may be thinking of putting money in an RRSP or tax-free savings account.
Neal Boyce, manager of wealth management at Crocus Credit Union, says why not do both?
An RRSP is a government approved plan through which you can save money for your retirement years, your contributions are tax-deductible and the income on those investments are tax-sheltered.
"Whereas with the tax-free savings account, your contributions are not tax-deductible, however, the income you earned is not taxable," Boyce said. "It’s with after-tax income you would invest in a TFSA."
Within either plan, any investment — low or high risk — is available, from stocks, to bonds, to mutual funds and everything in between.
"It’s whatever the investor feels comfortable with," Boyce said. "There’s no advantage to one over the other as far as what you can invest in."
So, which investment vehicle is best for you to save?
"Every situation should be taken individually," Boyce said.
If an investor expects to be in a lower tax bracket compared to when they’re working, an RRSP is advisable since the money taken from the RRSP at retirement is taxed less heavily than if the investor were in a higher tax bracket.
"If you have a client that’s in a position and they’re in a high tax bracket and at retirement they’re going to be in a lower tax bracket, an RRSP is a good option, whereby you can contribute money there and withdraw it in retirement when your tax bracket is lower, so you pay less tax at retirement than your peak working years."
But if an investor expects to be in the same tax bracket at retirement as they were before, an RRSP may not be the appropriate investment vehicle.
"So, if you have someone who will be in the same tax bracket at retirement as they are before, an RRSP may not be the plan for them," Boyce said.
In the majority of cases, people will reside in a lower tax bracket after retirement.
"Generally, in most cases, they do and an RRSP is a good option because ultimately you’re going to be taxed less on that money down the road.
Boyce said a TFSA is a good home for money destined for shorter-term spending on bigger ticket items within three to five years.
Any income made through investments within the TFSA won’t be subject to taxes since the money is already taxed before it goes into the investment.
"Any kind of income, whether it be interest on a term deposit or capital gains on a mutual fund or an equity," he said.
It is common for many investors to have money in both TFSAs and RRSPs, he said.
"The tax-free savings account may be a shorter term type of investment where you have a specific plan for that money down the road," he said. "RRSPs are more for retirement income, but the tax-free savings account can be used for that or other things — maybe a down payment on a first house, that type of thing.
"I find that tax-free savings accounts are a great place for setting aside money for something down the road, maybe maintenance repairs on the house, new car, a trip, something like that," Boyce said.
"Ultimately you get more money from that than you would a regular guaranteed deposit because you’re not paying tax on that income."
For young people, Boyce recommends to have money in both RRSPs and TFSAs.
"If you start early, with the magic of compounding, ultimately your deposits can grow so much bigger than if you start later on for your retirement," he said.
"But it’s also good to have a cushion for if an emergency comes along, you have something to draw from, like your tax-free savings account.
"Or if, an RRSP isn’t the best option, than a tax-free savings account is definitely the next best thing."
Later in life, if the investor is in a high tax bracket, an RRSP is an attractive option, but if you’ve maxed out your RRSP contributions, then a TFSA is a good option.
"Again, it could be a good option in both cases to split your money up in both TFSAs and RRSPs."
Investors can contribute up to $5,500 per year into their TFSAs and everyone can have up to $31,000 in it starting in 2009.
The $5,500 limit can be carried over to the next year if it isn’t reached.
How much risk an investor takes on is dependant on time constraints and, of course, personal comfort level with risk.
"If they’re investing for two or three years, the type of investment you want might be more conservative or guaranteed funds rather than a mutual fund for either an RRSP or TFSA," Boyce said.
"It’s really just your time horizon and your tolerance for risk — in either plan — which way to go."
Ted Billeck, vice-president of deposit and member services at Sunrise Credit Union, said it’s never too early to start looking at RRSPs.
"We encourage young people to begin thinking about and starting to invest in RRSPs as soon as they can, even if it is in modest amounts," he said. "While retirement may seem to be a long way off, the power of compounding can make a huge difference over a 30 to 40-year span.
"The RRSP contributions can also reduce the amount of income tax paid on their earnings providing them with additional discretionary income."
For young individuals, Billeck said, the TFSA is a good investment vehicle to save for a major expenditure whether it be a home, car, or vacation.
According to Billeck, individuals nearing retirement are usually in their peak earning years, and if they have been contributing to an RRSP or pension plan, have a good nest egg for their retirement. They may be debt-free or nearing that state as they prepare for retirement. They should continue to use their maximum contribution room to take advantage of allowable tax breaks and reduce their taxable income.
At this stage in life, there can be additional disposable income which is placed into savings. The TFSA is a good vehicle for this type of saving as the income is sheltered and when withdrawn in retirement is not taxable and can supplement pension incomes or be used for travel or other activities.
"During the mid-years of their working lives, individuals should continue to take advantage of their maximum pension contribution room by contributing to their RRSPs thereby reducing their taxable income and earning tax sheltered investment income," Billeck said. "Individuals should also establish a saving plan outside of their RRSP as an emergency fund for unforeseen expenses or for a particular purchase in the future.
"The TFSA is an excellent investment tool for this as it is available at any time and the investment income earned while in the plan is not taxable."
» Brandon Sun