WEALTH Matters ó WINTER 2012

RRSP vs TFSA

Itís that time of year again where the media is full of RRSP advertising. Itís encouraging to see more airtime devoted to Tax-Free Savings Accounts (TFSAs) now in their 5th year. TFSAs have relatively low contribution limits, but may in many cases be a superior vehicle to RRSPs depending on your particular situation.

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RRSP vs TFSA

Interest Rate Trends

Investment Market Commentary

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RRSP vs TFSA

Interest Rate Trends

Investment Market Commentary

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An easy rule of thumb is that the RRSP will be better only if your tax rate at the time of withdrawal is expected to be lower than it is at the time you contribute. Letís see why.

Letís assume our client is in a 33% tax bracket, which is the tax rate that applies to annual taxable income of $70-80,000. At this tax rate, an RRSP contribution of $150 would produce a tax refund of $50, for a net outlay of $100. So we compare $100 invested in a TFSA with $150 invested in an RRSP, because the net outlay in both cases is $100. Weíve used a 5% return in this example, which accumulates tax-free in both plans.

Of course the RRSP balance is always larger because more money was invested in the plan. But RRSP withdrawals are taxable income, so we have to net off the tax to find the net value. Surprisingly, if the tax rate on the withdrawal is the same as it was at time of deposit, the RRSP net value is the same as the TFSA.

Note the net RRSP values when 25% and 40% tax rates apply at the time of withdrawal. The RRSP is better than the TFSA when the rate is lower at withdrawal time, and worse when the rate is higher.

Make the decision thatís best for you. Have us prepare a long term cash flow projection to get a better idea of what tax bracket youíll be in when youíre ready to make withdrawals. This will help you decide in which years a TFSA contribution makes more sense than an RRSP contribution, or help identify low-tax-bracket years in the future, when an RRSP withdrawal may be worth more than a TFSA withdrawal.††

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TFSA

 

RRSP (at 33.33% tax rate)

Net

Net

Yr

Start

Interest

End

 

Start

Interest

End

Net Value

@25%

@40%

1

100.00

5.00

105.00

 

149.99

7.50

157.49

105.00

118.12

94.50

2

105.00

5.25

110.25

 

157.49

7.87

165.37

110.25

124.03

99.22

3

110.25

5.51

115.76

 

165.37

8.27

173.64

115.76

130.23

104.18

4

115.76

5.79

121.55

 

173.64

8.68

182.32

121.55

136.74

109.39

5

121.55

6.08

127.63

 

182.32

9.12

191.43

127.63

143.57

114.86

6

127.63

6.38

134.01

 

191.43

9.57

201.00

134.01

150.75

120.60

7

134.01

6.70

140.71

 

201.00

10.05

211.05

140.71

158.29

126.63

8

140.71

7.04

147.75

 

211.05

10.55

221.61

147.75

166.21

132.96

9

147.75

7.39

155.13

 

221.61

11.08

232.69

155.13

174.52

139.61

10

155.13

7.76

162.89

 

232.69

11.63

244.32

162.89

183.24

146.59