When does it make sense to move money from a TFSA to an RRSP?

# Withdraw from a TFSA to contribute to an RRSP?

Q: When does it make sense to withdraw money from a TFSA and move it to an RRSP? I am in my late 50s and considering doing this as I have a fairly high income and not much cash on hand to make RRSP contributions. Is that a good move for me?

—Deirdre T.

A: I like that you are thinking about ways to reduce tax, Deirdre, and if you’re careful it may be a good move; if not, it could be a big mistake.

There are two things to think about:

1. Will your tax rate in retirement be lower than it is now? If so this could be a good strategy.  Also think about things like the OAS clawback, the age credit, GIS, GST credit etc…
2. A TFSA contribution is an after-tax contribution and an RRSP contribution is a pre-tax contribution. A \$5,000 contribution to a TFSA is not the same as a \$5,000 contribution to an RRSP. If your marginal tax rate is 40% and you draw \$5,000 from your TFSA you’ll have \$5,000.  The same \$5,000 withdrawal from your RRSP will leave you with \$3,000, and that’s where you could make your mistake.

If your plan is to draw and contribute an equal amount from your TFSA to your RRSP then don’t do it.

If you know you’ll have a lower tax rate when you retire this is how you could approach it: first, figure out how much money to contribute to your RRSP so that if you withdraw it after you deposit it, it will be equal to the amount you are drawing from your TFSA. You can do this using the RRSP gross-up formula.  Here is an example using a \$5,000 contribution and a 40% marginal tax rate: \$5,000/(1-MTR (40%)) = \$8,333.

Now draw \$5,000 from your TFSA and then add another \$3,333 from your bank account or line of credit/loan.  When you complete your taxes and get the tax refund of \$3,333, you will replace the money in your bank account or pay off the line of credit/loan.

You may be thinking, why not just take \$5,000 from the TFSA and deposit it into my RRSP and use the refund to invest back into my TFSA or RRSP?  You could do that but you will have less after-tax income, assuming your marginal tax rate and the investment interest rate on both accounts are the same.

When you work it out, you’ll see that with a marginal tax rate of 40% the tax refund on \$5,000 is \$2,000. If you put the \$2,000 back into your RRSP you’ll have \$7,000 and the after-tax value is \$4,200, which is less than your original after-tax \$5,000 deposit.

If you are concerned about being in a higher tax bracket and you don’t have the money for an RRSP contribution, you may want to consider a 1-year RRSP loan.

Finally, you don’t want to use up all of the funds in your TFSA. An RRSP/RRIF is good for providing a regular income in retirement, but not so good if you need a large lump sum for a car, vacation, new roof, etc…. that is a good use for a TFSA.

Allan Norman, M.Sc., CFP, CIM, Atlantis Financial/IPC Investment Corp.