TFSA Advise?

steve41 said:

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.

Click to expand...

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.

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.