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Hello,

I am 29 and own a home and rental property (puchased in 2002 for $70k, currently valued at $150k.) that brings in $950 per month.

I have ~11k in RRSP's and a pension/profit sharing fund valued at 35k.

I currently have $5000 in a savings account, and my question is whether I should put this into my RRSP or open TFSA?

Any advise would be appreciated!
 

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An RRSP offers a tax deduction on the contribution, tax deferred compounding, and full taxation on withdrawal. The TFSA doesn't offer a tax deduction on the contribution, does offer tax free compounding and tax free withdrawals.

If you intend to use the money for retirement, like 20 - 30 years down the road, the benefit of the tax free withdrawal with the TFSA will be much greater than the benefit of the tax deduction for the RRSP contribution.

Save tax on the big amount in the future instead of the small amount at present. Use the TFSA.

Does this make sense?
 

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Save tax on the big amount in the future instead of the small amount at present. Use the TFSA.
Well... no. You are neglecting several important facts...

1. The time value of money. The RRSP tax refund is now, the tax on withdrawals is way out in time.

2. Tax rates in the future are much lower. The marginal tax rate when you are working is, in almost every case, higher than when you are retired.

3. There are age credits and deductions in retirement and, the tax brackets are indexed to inflation... tax on a fixed amount goes down over time.

If you anticipate the need for a rainy day draw on cash (a large withdrawal), or expect to die prematurely (i.e. you want to maximize the net to your estate) the TFSA makes sense. On the other hand, if you don't care about your estate, and you don't expect to make a major lump sum draw, the RRSP and the TFSA are pretty much equal.
 

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It depends if you would need this money in the upcoming years or not.

If your savings account is also your emergency funds, the TFSA is much better (no tax implication upon withdrawals).

However, if you don't need the 5K, you are better off contributing to your RRSP in order to save some taxes ;-)

I suggest you "double dip" your RRSP contribution (put the 5K and use your tax return in 2010 to add more money in your RRSP's ;-) ).
 

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Well... no. You are neglecting several important facts...

1. The time value of money. The RRSP tax refund is now, the tax on withdrawals is way out in time.

2. Tax rates in the future are much lower. The marginal tax rate when you are working is, in almost every case, higher than when you are retired.

3. There are age credits and deductions in retirement and, the tax brackets are indexed to inflation... tax on a fixed amount goes down over time.

If you anticipate the need for a rainy day draw on cash (a large withdrawal), or expect to die prematurely (i.e. you want to maximize the net to your estate) the TFSA makes sense. On the other hand, if you don't care about your estate, and you don't expect to make a major lump sum draw, the RRSP and the TFSA are pretty much equal.
Okay, let's try some numbers. Let's give the RRSP every advantage:

RRSP:

Tax rate: 40%
Annual contribution: $8,333 (equivalent to $5,000 after tax)
I/Y= 10 %
N = 36
FV= $2,492,623

Annual withdrawal for 25 years: $274,607 MINUS 40% tax = $164,764

TFSA:

Tax rate: 40%
Annual contribution: $5,000
I/Y= 10%
N=36
FV= $1,495,634

Annual withdrawal for 25 years: $164,771


It would appear that the TFSA and RRSP are almost identical, EXCEPT:

1. Tax in retirement for financially successful people is usually much HIGHER than while working, especially when OAS claw-back is taken into account.

2. TFSA withdrawals will NOT push other income into higher brackets.

3. TFSA will not affect other income tested benefits.

4. In this particular case, the person might put $5,000 into the RRSP, then contribute the $2,000 refund to the RRSP as well. It is very unlikely that he would contribute every ensuing refund to approach (but never reach) the $8,333 theoretical equivalency. Even if he did, the time value of money (waiting for those refunds) would degrade RRSP returns. If $5K in the TFSA is better than $8,333 in the RRSP anyway, the TFSA wins.

In my practice I've seen that most people need to make an emergency withdrawal from their RRSP once or more in their working lives; with the attendant tax consequence. For example, a person who loses their job and collects EI then supplements the EI income with RRSP withdrawals can face EI benefit repayment if the RRSP withdrawals are more than 40% of the weekly benefit or total taxable income for the year (employment income, EI benefits + RRSP withdrawals) is greater than $50,000.
 

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You are right... marginal tax rates can be higher in retirement, When I say the opposite is true, I mean that for a retirement planning projection, not an estate plan. I arbitrarily define a retirement plan as one in which, at some far age (95 or 100, say) the capital runs out. An estate plan is exactly equivalent in every way except that instead of setting an estate goal of zero (dying broke) you set an explicit estate goal.

When that estate goal is set high enough, granted, taxes can be higher in retirement than when working.

As I mentioned, if you don't expect a 'surprise' need for cash, but instead you can see a constant retirement lifestyle extending out to your die-broke age, the RRSP and the TFSA are pretty much equivalent. From an estate perspective, or if a lump sum need is in your future you should consider maxing your TFSA first.

To muddy the waters, if you set aside TFSA capital in anticipation of a surprise need and that need doesn't materialize, and you have diverted those TFSA funds away from your RRSP.... you may be disadvantaged ATI-wise.
 

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Discussion Starter #8
Thanks for the advise, everyone. TFSA comes out on top for me based on the possible need to make withdrawls.

Thanks again!
 

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I personally prefer TFSA, because the earnings there are non-taxable (for now :)), however you should speak to accountant regarding that.
As Mike H. previously mentioned if you invest in the RRSP at optimal efficiency it works out to be identical to the TFSA in the long haul. If your income is less in retirement, the RRSP can work out to be even better than the TFSA. The opposite is true if your income is higher or some of your government benefits are clawed back because you are earning too much (for the average middle class this will not be the case).

Overall though, I would gravitate towards the TFSA due to its simplicity and flexibility. Wait and use the RRSP when you are in your peak earning years and closer to retirement so it will be much easier to see the whole retirement picture.
 
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