Should I contribute to a TFSA, RRSP or both?
Should I contribute to a TFSA, RRSP or both?
With the Tax-Free Savings Account (TFSA) available for saving in a tax-free environment, does it still make sense to contribute to a Registered Retirement Savings Plan (RRSP)?
RRSPs can work well if you contribute while you are in a high tax bracket and withdraw when in a lower tax bracket. You can generate a higher net rate of return with an RRSP when the effective tax rate at the time of withdrawal is lower than the effective tax rate at the time of contribution. A TFSA can provide a higher return if the reverse occurs.
For example, if you contribute $1,000 to an RRSP when you are in a 20 per cent tax bracket, your net cost is $800 after the tax savings. If you are in the same tax bracket when you make a withdrawal from your RRSP, your net withdrawal will be equal to your net cost after paying the taxes ($800). However, if you are in a higher tax bracket when you make the withdrawal, say 40 per cent, then your net withdrawal will only be $600 after the taxes are paid (assuming market is flat and there is no return).
TFSA, RRSP OR BOTH?
A TFSA can be an ideal savings vehicle if you are in a low income tax bracket. RRSPs may not be well suited to low income Canadians. The RRSP tax savings are insignificant and you may be in a higher tax bracket when you make withdrawals, as the earlier example demonstrates. You may also want to consider that TFSA withdrawals do not impact income tested benefits and credits, such as child tax benefits and credits, Old Age Security (OAS) or Guaranteed Income Supplement (GIS).
If you now find yourself in a lower tax bracket, such as when on maternity leave, and have made RRSP contributions in the past, you may want to consider withdrawing from your RRSP to make a TFSA contribution. However, remember that funds withdrawn from your RRSP cannot be re-contributed at a later date.
One strategy would be to contribute to your TFSA now and accumulate RRSP room to be used later when in a higher tax bracket to optimize the tax benefits.
This is a situation where you may want to maximize both your RRSP and TFSA contributions. In fact, the tax savings or refund received from the RRSP contribution could be used to fund the TFSA.
YOU MAY WANT TO RETHINK YOUR HOME BUYERS PLAN SAVINGS
If you are saving for a down payment on a house, a TFSA might be a better option than saving in an RRSP and withdrawing under the Home Buyers Plan (HBP). There are several reasons for this.
■ The flexibility to recontribute the TFSA withdrawal without time limits.1 If HBP repayments are not made on time, the annual repayment amount is added into your income and any missed repayment amount means the RRSP room is lost forever
■ There is no restriction on how much you can withdraw from your TFSA while the HBP restricts you to $25,000 from each your RRSP and your spouses RRSP. Alternatively, you could each contribute $5,000 a year for 5 years to a TFSA and then withdraw $25,000 plus any investment earnings tax free and with no required repayments
■ There are no conditions on TFSA withdrawals, whereas the HBP requires you to be a first time home buyer.
Similar logic could be applied to the Life Long Learning Plan. By using a TFSA to save and fund continuing education, contributors can gain increased withdrawal flexibility while eliminating any enrollment requirements or repayment conditions.
Whether to save in a TFSA, RRSP or both may depend on your savings needs, your eligibility for income tested benefits and your current and expected future financial situation and income level.
1 Amounts withdrawn in a taxation year will be reflected in contribution room in the following year.
Article courtesy of Manulife Financial and should not be relied upon for investment or tax advice. It is recommended to speak to a financial planner to review your particular situation.
10 Steps to Buying a Home
1 Determine how much you can afford. Based on your down payment, income, existing debt, regular expenditures, and other key financial information, we can help you determine how much you can afford to pay every month and the price range that works within your budget. 2 Team up with a real estate agent. Finding a real estate agent to help you search for your dream home is important to the home buying process. The best real estate agent will be a combination of a personal advisor, consultant, and negotiator. This expert will show you homes that match your criteria, guide you through the home buying process, and negotiate the best possible price for your home. 3 Make an offer. When you’ve found a place that you’d like to call your own, your real estate agent will help you draw up an Offer to Purchase to present to the seller. This legal document specifies the price, the closing date, and any conditions. 4 Retain a lawyer. It’s important to hire a lawyer who specializes in real estate. You could find yourself in a bidding war for the home you want, and you may want a lawyer to look over any offer to purchase before you submit. 5 Arrange the home inspection. Many buyers consider including a home inspection as one of the conditions on their Offer to Purchase. A professional inspection is a good way to uncover major problems with the home. If the home doesn’t pass the inspection, you can adjust or withdraw your conditional offer. 6 Get the mortgage approved. With a copy of the signed Offer to Purchase and the necessary financial information, we’ll submit your application to the mortgage lender that we have selected. The lender will qualify the application and complete a valuation on the property you have purchased. Mortgage insurance gives you the ability to buy a home with a down payment of less than 20% of the purchase price. 7 Get property insurance. Apart from the mortgage, you’ll need to purchase property insurance that protects your home against fire and other damages. Once you have a policy in place, forward a copy to your lawyer. 8 Check the legal details. With the deal finalized and the financing in place, your lawyer can now search the title and check whether there are any unpaid property taxes outstanding. Your lawyer will arrange for a survey to be completed, if necessary. 9 Complete the paperwork. A few days before the deal is set to close, you’ll meet with your lawyer to review, sign, and get copies of all the documentation. At this time, you’ll also provide the remainder of your down payment and pay legal fees and any additional costs, such as prepaid utility expenses for which the seller should be reimbursed, that are due on closing. 10 Pick up the keys. On the closing day, your lawyer and the seller’s lawyer will exchange documents and cheques. Your lawyer will also register your new home in your name. When these tasks are complete, you’ll get the deed and your keys to your new home, and you can move in