We’ve discussed some of the various savings vehicles and types of investments that can be made in some earlier posts. Armed with that knowledge, a logical next step to ask is “Are these saving vehicles all the same?“. Well, not exactly.
Not only can you prioritize different saving vehicles depending on your income, but as you start amassing enough wealth in these accounts, you can improve further with tax efficiencies of your returns. For example, holding U.S. equities in your RRSP** due to dividend tax credits – this is Grade A preferential treatment you don’t get in your TFSA***! But this is another conversation.
To begin, we must determine the best place from an income tax perspective, that you can plop your money down. Optimizing which account to tackle first can get the ball rolling as you do your best to maximize savings and flexibility.
Let’s get started!
$40K Income or Less
For those individuals making $40K or less, I recommend investing in your TFSA first. That being said, if your employer offers an employer match on a DCPP, take full advantage as that’s an immediate 100% return on your investment. Thereafter though, a TFSA may fit your situation better than applying more dollars into an RRSP.
The reason is that RRSP contributions are pre-tax. But the tax shield you gain at a $40K income level is not too significant as most provinces have their first tax rate going up to roughly this number (See this helpful KPMG table for more details).
And remember, you are only deferring taxes. If you are expecting to be in a higher income tax bracket come retirement, you’re only deferring taxes to eventually pay more in taxes.
By prioritizing the TFSA, you are using after-tax dollars at the lowest income tax rates to earn non-taxable gains. There is also additional flexibility with a TFSA. You can withdraw amounts at anytime and re-contribute the following calendar year once you regain that contribution room!
For lower income folks, the real kicker is that any income generated by the TFSA in your retirement is not part of the income testing for social programs and tax credits like CPP, OAS, GIS or provincial programs like Ontario’s Sales Tax Credit. So you could attempt to structure a retirement income such that:
- Pull out a small enough amount from your RRSP/RRIF so as to limit income tax and still be able to collect the full OAS, GIS, and possibly Sales Tax Credits;
- Supplement remaining required income with TFSA withdrawals;
As a lower income individual the TFSA makes sense as a priority account. The tax benefit if pushing savings into an RRSP first would likely not offset the tax free growth and flexibility of the TFSA. Not to mention income from RRSP/RRIF will count in clawbacks of the possibly highly valuable OAS, GIS, or Sales Tax Credits.
$40K Income or More
If you’re making over $40K, I recommend going with your DCPP/RRSP first. While the TFSA has additional flexibility as mentioned above, you may not be qualifying for GIS or Sales Tax Credits.
For high income earners making $90K or more, it becomes even more apparent you will not qualify for GIS/Sales Tax Credits while simultaneously you gain a more enticing tax shield when choosing pre-tax accounts.
As an example, for those making $93K or more in Ontario, your combined Federal and Provincial tax shield is 37.16%. If you plan to have taxable income of about $60K-$80K in retirement, your marginal tax rate drops to 29.65% in retirement. Purely from an income tax perspective, you’re going to prosper almost +12%. Not too shabby.
In an ideal world, you can contribute the maximum to both your TFSA and DCPP/RRSP.
In the real world, life gets in the way. Knowing your priorities for your own goals is important and hopefully this gives some basic guidelines for which accounts to prioritize for retirement!
*Note this post is geared towards where to put retirement money. If you’re still putting aside money for a short-term goal like a house down payment, a TFSA is ideal.
**RRSPs have a maximum contribution equal to the minimum of 18% of prior year’s taxable income and $26,230 (this amount is indexed every year). RRSPs contribution room is also cumulative, so you can make up for contributions later if necessary!
***TFSAs currently have a maximum contribution of $5,500 for 2018. Note the room is cumulative and as the TFSA began in 2009, you have $57,500 of room as of 2018. Any amount you withdraw, you’ll get that contribution room back the following calendar year.