Like many Canadians, Tia won't be able to contribute the maximum to both a TFSA and an RRSP. Her question is: which one of the two will help me save more?
Let's say Tia has $1,000 to contribute to a TFSA and RRSP, and:
- She doesn't add any more money to the plan after this contribution
- She invests this money for 20 years
- Her savings grow 5.5 percent each year
- Her marginal tax rate is 40 percent.
Here's what Tia would save with each plan.
| Tia's pre-tax contribution
| Tax she pays upfront on her contribution (at 40%)
| Net contribution
| What she makes investing (20 years at 5.5%)
| Total in each plan after 20 years
| Tax due when she withdraws the money (at 40%)
|Cash in hand after 20 years
Source: Department of Finance, Canada
There are three important lessons for Tia from this story:
- If her tax rate were to stay the same 20 years from now, she would end up with the same cash in hand from both plans.
- If her tax rate were to drop, she would gain more from an RRSP. This might be the case if Tia knew she would retire in 20 years and her yearly income would drop – bringing her tax rate down.
- If her tax rate were to rise after 20 years, a TFSA would be the better choice. For example, let's say Tia knew she would still be working at that time, and her income would be higher. So would her tax rate. By taking money from her TFSA, she would come out ahead in tax savings over an RRSP.
Of course, no one has a crystal ball. No one can foresee the future – including any changes that may come to Canada's tax system over time. Still, taxes are a major factor in choosing between an RRSP and a TFSA and it pays to plan with the best information you have today.