Gail’s take: RRSP vs. TFSA

When it pays to save using an RRSP and when a TFSA makes more sense.

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savings_pig_322There’s a lot of yada-yada about how much tax folks will have to pay on RRSP withdrawals, and the idea of whether or not it will be worth it. It’s the big argument being used in favour of TFSAs. It’s time to clarify.

First there’s the whole idea of whether an RRSP is even worth the effort because of the way it affects other retirement income in terms of taxes. This is a two-pronged issue.

1. For people who are on a very limited income, who will likely make as much or almost as much from their government pensions (CPP/OAS) as from working, then setting money aside in an RRSP makes very little sense. Since they will be replacing most of their income with government pensions and their income is so low that RRSP contributions would affect their quality of life now, these people need to focus on an emergency fund and on having some fun.

2. For the people who will make so much from their pension (private and government) that their personal (RRSP) savings add very little more needed income, a TFSA makes more sense.

Next there’s the whole growth inside the RRSP thing. When you start contributing to an RRSP at a young age, and have 30, 35, or 40 years to watch the money compound on a tax-deferred basis, the growth inside an RRSP is staggeringly higher than outside an RRSP. Let’s say you have $10,000 to invest and your marginal tax rate is 35%. Outside an RRSP that $10,000 will grow to $21,598, assuming a return of just 4% over 30 years. Inside an RRSP you would have  $32,434. That’s $10,836 more inside an RRSP on a single $10,000 contribution. I’m not sneezing, are you?

The tax advantage is also nothing to be sneezed at. If you pay tax at 30% and put $10,000 in an RRSP, you will receive a tax refund of $3,000 that you can then use to pay down a mortgage, build educational savings or have some fun. It’s a bird in the hand now.

Please remember that the RRSP was created so people who did not have a company pension plan would have the same opportunity to build retirement assets as those lucky enough to belong to a plan at work.

There are no right or wrong answers to the RRSP vs. TFSA debate; it all boils down to “What works for you?”

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