No matter what your plans for 2020 were, odds are they got turned on their head. For the better or worse, your finances were probably part of those changes. We realize our members face a variety of diverse circumstances and there are three different situations many are finding themselves in: Been better, doing okay, or doing better than before. When a storm is brewing, you batten down the hatches before it hits. We want to ensure you have the information you need to prepare your finances for whatever weather is on the horizon. Depending on which boat you’re finding yourself in, this could mean preparing an emergency fund or perhaps adding a bit more to your future retirement. Regardless of your situation, the answer is to save.
The question lies in where you should save your money, in a Tax Free Savings Account (TFSA) or a Registered Retirement Savings Plan (RRSP)? There are a few things to consider before choosing the right account for your situation:
Will you want easy access to your savings?
If you’re planning on using the money in the near future (think of that postponed wedding you’re hoping to have next year) you’ll probably want to put your money in a TFSA. A TFSA is also a great place to store that “just in case” money you might save up in case your financial situation is impacted in the coming months by the pandemic. The money you put into your TFSA is after-tax dollars and the money you earn on your investment is not taxed. The benefit of a TFSA is that you can withdraw it at any time without the worry of increasing your taxable income.
If not, do you predict your income tax rate will be lower in retirement?
If you don’t plan on needing your additional funds within the next year or so, you could place this money into an RRSP to help with your retirement savings. Because you deduct RRSP contributions from your taxable income, your RRSP savings are considered pre-tax dollars. This means you will have to pay taxes when you begin to draw money from your RRSP account.
For most Canadians, their personal tax rate will be lower in retirement so it’s advantageous to claim deductions now, when their personal tax rate is higher, and withdraw the money in retirement when their personal tax rate is lower.
Here’s how your taxes might break down if your yearly working salary is between $48,535 and $83,451 with a predicted lower retirement income:
| TFSA | RRSP | |
| Your pre-tax contribution | $1000 | $1000 |
| Tax you’ll pay on the $1,000 contribution, at 28.2% | 0 | |
| Net contribution (2020) | 718 | 1000 |
| What you’ll make investing 20 years at 5.5% | 1377 | 1918 |
| Total in each plan after 20 years (2040) | 2095 | 2918 |
| Tax due when you withdraw the money, at 20.06% | 0 | 585 |
| Cash in hand in 2040 | $2095 | $2333 |
However, when you combine your income in retirement from RRSPs, workplace pensions, Canada Pension Plan (CPP), Old Age Security (OAS), and Guaranteed Income Supplement (GIS) you may find that having a tax-free source of income is beneficial. No matter what your income or tax margin is, you won’t have to report TFSA withdrawals as income, or pay tax on them.
Here’s how your taxes might break down if your yearly salary is between $48,535 and $83,451 with a higher a predicted higher retirement income.
| TFSA | RRSP | |
| Your pre-tax contribution | $1000 | $1000 |
| Tax you’ll pay upfront on your contribution, at 28.2% | 282 | 0 |
| Net contribution (2020) | 718 | 1000 |
| What you’ll make investing 20 years at 5.5% | 1377 | 1918 |
| Total in each plan after 20 years (2040) | 2095 | 2918 |
| Tax due when you withdraw the money, at 31% | 0 | 905 |
| Cash in hand in 2040 | $2095 | $2013 |
Have you maxed out contributions to your RRSP already?
While RRSP and TFSA guidelines were created to encourage Canadians to save, there are significant penalties for over-contributing to these plans. RRSP contribution limits are set at 18% of your earned income annually, and you can carry forward unused contribution room. There may be years when you have more to invest than your RRSP room allows, in which case, your TFSA is a great place to invest that money. Your savings will grow, tax-free, and you’ll be able to withdraw the money, tax-free. As of 2020, you can have up to $69,500 in your TFSA.
Do you qualify for government programs that supplement your income?
TFSA withdrawals won’t have an impact on your ability to qualify for government benefits you may receive. Lower-income households continue to qualify for the Canada Child Tax Benefit, Old Age Security (OAS), the Guaranteed Income Supplement (GIS), the Shelter Aid for Elderly Renters (SAFER) program, and/or BC Employment and Assistance (BCEA) – regardless of the amount drawn from TFSAs.
No matter which financial boat you’re finding yourself floating in these days, we’re here to learn about your situation and help you to weather the financial storm caused by the pandemic.