Aim to maximize your RRSP and TFSA

It’s best to contribute as much as you can to both your RRSP and your TFSA. But that’s hard to do. The Investment Reporter outlines two strategies to assist you in maximizing your contributions. If you must choose between them, your situation should set your choice.

Maximize_your_RRSP_and_TFSAIdeally, you would maximize contributions to your RRSP (Registered Retirement Savings Plan) and your TFSA (Tax Free Savings Account). But doing so would soak up a lot of your cash.

You can contribute up to 18 per cent of your earned income to your RRSP—less the pension adjustment if you’re lucky enough to work for an employer who pays pensions. In 2018, you can contribute $5,500 to your TFSA. If you have never contributed to a TFSA, you can contribute up to $57,500—if you were at least 18 when the late finance minister, Jim Flaherty, created it in 2009.

Many workers lack the cash to maximize contributions to their RRSPs and TFSAs. Their contribution room grows each year. But if they can’t maximize their contributions in 2018, they’re unlikely to do so in 2019. Here are two strategies to help you contribute more to your RRSP and TFSA.

Two strategies to contribute more

One is to contribute to your RRSP. This will produce an income tax break. You can then contribute your income tax refund to your TFSA.

A second strategy is to raise your cash flow by cutting the tax taken off your paycheques. You then have more cash to contribute. Just fill in form T1213 (Request to Reduce Tax Deductions at Source). The deductions and non-refundable tax credits you can claim include RRSP contributions, child care expenses, support payments, employment costs, carrying charges and interest costs on investment loans, medical costs and charitable donations.

If you earn little income, then a TFSA looks preferable to a RRSP. First, since you pay no or little income tax, the tax break on RRSP contributions will save you little if anything. Second, when you withdraw cash from a RRSP, it counts as income. This could reduce or eliminate benefits from the GIS (Guaranteed Income Supplement) and OAS (Old Age Security). This is also true of withdrawals from a RRIF (Registered Retirement Income Fund). Money withdrawn from a TFSA does not count as income. These withdrawals do not jeopardize means-tested benefits.

If you aim to make large share price gains, then a TFSA looks preferable to a RRSP. That’s because you can sell and reinvest or withdraw the profits tax free. TFSAs are also preferable to RRSPs to save. You can quickly withdraw all the cash.

Can you resist raiding the TFSA pot?

One weakness of TFSAs is they’re too accessible—to buy a house, do renovations, take a trip and so on. It’s human nature to raid the pot. So will people save much for retirement? With RRSPs, few will withdraw cash in their working years. That’s because RRSP withdrawals are taxable and face withholding taxes. RRSPs also offer other benefits that are sometimes overlooked.

One big advantage of an RRSP is that the money can compound for many years, or even decades. That is, you can reinvest returns to generate even more returns. If a TFSA is frequently raided, there won’t be much money left to compound.

A second advantage of an RRSP is that contributions can lead to substantial income tax breaks. This is particularly advantageous for those who earn at lot and pay a high marginal tax rate. If you expect to pay a lower tax rate in retirement than you are in your working years, then an RRSP is even more beneficial. Contributions to a TFSA provide no income tax break, of course.

Buy US dividend stocks in your RRSP

If you plan to invest in dividend-paying American stocks, it’s best to buy them in your RRSP. Thanks to a tax treaty between Canada and the United States, there’s no withholding tax on US dividends paid to RRSPs. But the Internal Revenue Service (the US tax department) will withhold 15 per cent of US dividends paid to TFSAs.

It’s best to maximize your contributions to both your RRSP and TFSA. To come closer to achieving this goal, consider using the two strategies outlined above. If you must choose between a RRSP and a TFSA, take account of your situation. Particularly how much you earn and what tax rate you pay now and expect to pay in retirement.

This is an edited version of an article that was originally published for subscribers in the November 2, 2018, issue of The Investment Reporter. You can profit from the award-winning advice subscribers receive regularly in The Investment Reporter.

The Investment Reporter, MPL Communications Inc.
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