Senior Financial Planner, Tridelta
Certified Financial Planner, Ed Rempel & Associates
Which is better?
Ed Rempel: For most clients, some sort of combination of the two is usually the best strategy. When deciding which, it comes down to two main factors: First, what your marginal tax rate is today, versus what it’s going to be after you retire. Second, what you use your tax refund for.
How you use your RRSP tax refund is a really big part of the planning strategy. Most Canadians tend to spend their refunds. For the best results, however, you can either reinvest that refund into an RESP or TFSA or follow a gross-up strategy.
Take Rob, for example. He’s expecting a $10,000 bonus in February. Effectively he only gets $6,000 after tax. But he could borrow $4,000 from a line of credit or loan and make a $10,000 contribution to his RRSP; and then get back the $4,000 in refund and almost immediately repay the loan.
An RRSP only really keeps up with the TFSA if you’re grossing-up every single year – if you retire at the same tax bracket as your earning years, the RRSP is 10% behind the TFSA. So grossing-up every single year is the only way an RRSP can keep up with a TFSA.
It’s a planners’ dream if senior clients have a balanced portfolio of both RRSPs and TFSAs when they retire. We could do lot of planning around how much money to take out of each to keep our clients in a lower tax bracket.
Frank Wiginton: The TFSA has very little benefit at this stage, but when we plan out 25-to-30 years it will become a very powerful tax-controlling tool. But at this point in time an RRSP still seems the better option for most people who are in a 30% tax bracket or better.
A majority of our clients are retired or nearing retirement. When we plan 25 years out – depending on their age – we look at the estate planning aspect and how we can use the TFSA to reduce the lifetime tax and death tax. We also see the TFSA as a good option for people who generate very low income.
After a certain level of income RRSPs can give you a much better value. Many times we build out our plans where we actually withdraw more than a minimum out of RRSP accounts to draw them down, so there’s very little remaining on second death. That allows us to control tax rates for our clients to keep them in a very low tax bracket over their retirements. Oftentimes they don’t need that money, so we build it up in their TFSAs. That money, upon second death, can transfer to charities, heirs or beneficiaries without any tax.
Ed: It’s hard to generalize. Each client’s needs and goals are different. If I were to make a generalization, however, I’d say RRSP is still the main savings vehicle for advisors because most of our clients are in higher income brackets. Right now, the biggest shortcoming of the TFSA is it only allows a $5,000 contribution room. Most people need to save more than that for retirement.
However, most people tend to think they’re going to be in a lower tax bracket when they retire, but when you include the four different claw-back programs that could kick in at retirement – most seniors at income levels from $0 to $95,000 are in one claw back program or other – they might effectively be in an even higher tax bracket than when they were working. So it takes a bit of planning to determine each client’s individual circumstance before deciding which is a better vehicle.
You don’t want to build too huge an RRSP, because then it’s very hard to stay in a low tax bracket when you retire. That’s when TFSAs can be useful – just before and after retirement – to make sure clients are in the right marginal tax bracket.
Sometimes it’s better to put in very little into an RRSP just before your client retires and build up tax-free saving or non-RRSP account, especially for the low income clients, and then take out a lot of money when they turn 65, and collect the GIS.
Ideal candidate for TFSA?
Frank: If I had to choose one, I’d say the lower-income group, or the younger clients who don’t have enough money to max out their RRSPs and not much contribution room. Such clients might not be get a tax refund, but the $5,000 is a savings opportunity and if they’re investing every single year and do that for 35 years, at a 6% annual rate of return, and let’s say it grows to $500,000. If you put that amount in an RRSP they’d end up paying more tax in retirement. Even if they got a 15% refund on their RRSP each year, when they RRIF they’d pay 25% tax on it because they’re taking out large amounts and their tax income goes up. They end up paying 10% more using an RRSP, versus a TFSA.