Registered Retirement Savings Plan or Tax Free Savings Account?
With the RSP deadline quickly approaching, many Canadians are wondering how much they should contribute to their RRSP – if anything. Before the introduction of the Tax Free Savings Account, the decision to put money into your RRSP was much easier. The general concept was that individuals would make a contribution into their RRSP, receive a tax refund, and their RRSP would grow tax free. Individuals would only be required to pay tax in later years when the money was withdrawn from the RRSP. The strategy for most people was to put the money into an RRSP when their income and tax rate was higher – creating a larger refund – then take the money out when their income was reduced and tax rates were lower.
In 2009 the Federal Government introduced the Tax Free Savings Account. This new account allowed Canadians to put up to $5,000 per year ($5,500 for 2013) into an investment account and earn income within the account tax free.
Main stream financial planning recommends that clients first maximize their RRSP, and then contribute any excess financial resources into a Tax Free Savings Account. This strategy is most effective for those with incomes in excess of about $42,000, but it may not necessarily be as effective for those with lower incomes as there is no change in tax rates from when the money is put in verses when it is drawn out in later years.
Money invested in an RRSP is fully taxable to single or widowed Canadians’ estates upon their death. A large RRSP can draw a hefty tax bill of up to 46% if this is the case. Money invested in a Tax Free Savings Account can transfer both tax and probate free if the account has a named beneficiary.
Investing in an RRSP for those with lower incomes can still be an effective strategy if you plan to use the current tax refund to pay down debt or reinvest into next year’s RRSP, or if you have difficulty saving and are looking for a forced way of saving for your future.
Every situation is different and we recommend you seek the advice of your financial advisor before taking action on any strategy.
Next month we will share some thoughts on why it may make sense to take money out of your RRSP sooner rather than later.