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Can RRSP Return More Money Then TFSA

4K views 13 replies 13 participants last post by  Nerd Investor 
#1 ·
I am wondering if my understanding of how RRSP/TFSA works is correct. In addition, I am wondering if I can leverage my tax refund and take advantage of compound interest to generate more money then with a TFSA?

My examples are a bit rough, but my understanding is that you get taxed up front with TFSA where-as your taxes are deferred with RRSP. If you are to re-invest your tax refund from your RRSP, would it yield a larger return? Essentially, I am trying to take advantage of putting in as much money as early as possible into my RRSP to take maximum advantage of compound interest.


RRSP Example:

Lets say I start with an initial amount of $0, and have a yearly contribution of $1000 in my RRSP account. Lets say that the rate of return on my investment is 10% (after all outstanding service fees). When contributing to an RRSP, you get a tax refund. Lets say that I receive a tax refund of $500 which I also deposit into my RRSP on top of my $1000 yearly contribution. In that case, a five year table would look something like:

YearDeposit AmountRate of ReturnMath to get AmountAmount
1$100010%(0 + 1000) * 1.1$1100
2$1000 + $50010%(1500 + 1100) * 1.1$2860
3$1000 + $50010%(1500 + 2860) * 1.1$4796
4$1000 + $50010%(1500 + 4796) * 1.1$6925
5$1000 + $50010%(1500 + 6925) * 1.1$9267

After 5 years, I would have $9267. If I were to take all of this money out, I would be taxed at 15% therefore I would only get to pocket $9267 * 0.85 = $7876.


TFSA Example:

Lets run through the same scenario but with a TFSA account. Again, I will have an initial amount of $0, and a yearly contribution of $1000. The rate of return will remain at 10%. A five year table would look like:

YearDeposit AmountRate of ReturnMath to get AmountAmount
1$100010%(0 + 1000) * 1.1$1100
2$100010%(0 + 1100) * 1.1$2310
3$100010%(1000 + 2310) * 1.1$3641
4$100010%(1000 + 3641) * 1.1$5105
5$100010%(1000 + 5105) * 1.1$6715

After 5 years, I would have $6205. If I were to withdraw this money, I do not have to pay any taxes therefore I would get to pocket $6715.


Conclusion

If my understanding is correct, since you get taxed the same amount with RRSA and TFSA, it would be more advantageous to go with an RRSP account and re-invest your tax refund into your RRSP account.
 
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#2 ·
Nice tables! But there are a couple of flaws in your argument.

1. You say you would get a tax refund of $500. This assumes that your marginal tax rate is 50%. Many people will not be in this tax bracket. On withdrawal, you suddenly assume a tax rate of 15%. Presumably you are looking at a situation where you retire at the end of Year 5.

Many people, on retiring, will have a lower marginal tax rate than before. But if they have pensions and/or other income (say, from non-tax sheltered investments), that is not necessarily the case. And if you are 71, your mandatory RRSP withdrawals may put you into a higher tax bracket. If your tax rate remained the same as before, you would pay 50%, leaving you with $4633.50. And if you left Canada, you would pay 25%.

2. I know it's just an example, but 10% is not a realistic rate of return for even an aggressive investor these days. Why not redo the calculations using 5%?

The bottom line is that the RRSP is an ideal tax shelter for someone who can invest in it while in a high marginal tax bracket, will consistently invest the refund (up to the limit) and withdraw while in a low tax bracket.

The TFSA is an ideal tax shelter for people who can invest in it while they are in a low marginal tax bracket. That includes many young people and many retired people. It's also worthwhile for people in a high tax bracket who have money to spare after investing in their RRSP.

So, the answer is: it depends on the context.
 
#4 ·
I am wondering if my understanding of how RRSP/TFSA works is correct. In addition, I am wondering if I can leverage my tax refund and take advantage of compound interest to generate more money then with a TFSA?
My examples are a bit rough, but my understanding is that you get taxed up front with TFSA where-as your taxes are deferred with RRSP ...
As heyjude mentions, the refund of $500 means the tax rate at contribution is 50%. The assumed withdrawal rate is 15%.
Question is .... how likely is such a wild swing in taxable income rates?

To put it in terms of income, using the 2016 Ontario tax rates - to get a 47.97% refund, one needs taxable income at or over $151K. For the withdrawal, the first $41,536 is taxed at 20% so it looks like at minimum, the withdrawal taxes are off by 5%.
http://www.taxtips.ca/taxrates/on.htm


Is there a real life scenario that will enable such wild swings in income, without other sources of income (ex. gov't pensions, company pensions, investment income) affecting the ranges?


Cheers
 
#8 · (Edited)
Limited circumstances if everything is out of one's income. While a spousal RRSP may make it a lot easier, it is probably more like 50%/20% as most of the provinces with the Feds taxes added in, start the tax rate at 20% or more.


The OP seemed more interested in what can happen so they would know if a spousal RRSP is possible.



Cheers
 
#7 ·
Kool:

Great that you are thinking about the effects of taxes and saving for the future. I'd suggest not getting to worried about things you can't control or foresee. Take advantage of free money resp and company matching plans. I think one would be better maxing out their tfsa, then contribute to an rrsp. Also don't spend the tax refunds each year, but reinvest the money. My preference is to stick with dividend growth stocks and avoid etf's (I'd rather not buy all to get diversification, regardless how low the fees are).
 
#9 ·
Like others have said, there are so many different factors that go into which one is better. And many of those are things we can't control or don't know at the time we start investing. You can put whatever number to it that you want, but trying to figure out your marginal tax rate at 70 when you are 30, you'd might as well throw a dart at a board.

But from what I've seen, most normal scenarios end up being pretty close between the two. They are both good approaches and for the majority of people with the means to invest significantly in both, there usually isn't a wrong answer. If you have the opportunity for any sort of RRSP match or anything jump on that.

Otherwise my recommendation would be, put money into the TFSA when you are young and starting out, then if you run out of contribution room, fill up the RRSP.
 
#10 ·
Otherwise my recommendation would be, put money into the TFSA when you are young and starting out, then if you run out of contribution room, fill up the RRSP.
+1 and some.

Don't worry about which one is better, max out both if you can, over time and then you don't have to worry about the debate.
 
#11 ·
And the problem with contributing to a spousal RRSP to take advantage of a massive difference in tax rates is that there are attribution rules that go back to you if withdrawn within 3 calendar years of contribution.

Another factor - if you put in your money into an RRSP by end of February and efile you might have your refund within 2 weeks so you have that additional time for the refund to be working for you as opposed to the table which shows a year later.

Did anyone include the basic personal amount in their marginal tax calculations? Your overall tax rate does not equal your marginal tax rate until you are making over 30 million dollars (not dividend or capital gains) if taxtips is right. (I think there are bugs... I put in ON and plugged in some numbers and $200,999 of employment income generated a 67% tax refund on a $1,000 RRSP contribution).
 
#13 ·
If you can't max one or both, then the debate can be endless.

That being said, to me it would come down to factors such as job stability, and if you have an emergency fund. If your job situation isn't stable, or if you don't have anything set aside for unexpected expenses, then I'd go with the TFSA, in either a high-rate savings account, money market fund, or similar safe investment. Otherwise, a good option is to contribute to your RSP, and then use the tax refund to put into your TFSA. Again, your situation, and personal preferences are going to make all the difference.
 
#14 ·
If you can't max both, ask yourself if it's more likely that you'll be in a higher or lower tax bracket when you withdraw compared to now.
If your marginal tax rate now > withdrawal = Max RRSP first
If your marginal tax rate now < withdrawal = Max TFSA

If you expect it to be about the same... flip a coin :)
 
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