Uh oh: Your Finances

With the RRSP deadline looming  (it’s less than one short week away), some of you still haven’t decided whether or not you’re going to contribute this year.  You have in the past because the allure of receiving a portion of your taxes back immediately trumped the knowledge that you’ll have to incur those taxes when you’re retired.

Well, before you contribute to your RRSP account this year, I want you to think for a minute about another investment vehicle available to you.

In January 2009, the Canadian government introduced the Tax Free Savings Account (TFSA), which many of you are already familiar with.  I’m going to recap the RRSP’s and TFSA’s benefits and disadvantages to help you decide where to invest your savings (assuming you aren’t investing them all in the extensive draught beer selection at the bar near your house).

RRSP account

Pros:

  • You’ll receive a tax deduction if you contribute within your limit
  • Tax-free compounding over time (you don’t pay taxes on the interest, dividends or capital gains the savings earn)
  • Several investment options available within the RRSP
  • Helps you save for the future (ie. all the bingo you will be playing in your 70s)

Cons:

  • You will incur income taxes upon redemption during your retirement
  • You will be charged a fee if you redeem any of your contributions before retirement (exceptions are the purchase of your first home or paying for post-secondary education).  You may consider this a benefit if it helps you ensure your retirement savings remain saved.
  • Maximum investment is your CRA contribution limit

TFSA

Pros:

  • Tax-free compounding over time (you don’t pay taxes on the interest, dividends or capital gains your savings earn)
  • Accessibility: you can dip into these savings without financial penalty at any time
  • Several investment options available within the TFSA

Cons:

  • Investing in a TFSA does not yield a tax deduction
  • Maximum investment is $5,000 per calendar year

If you’re still unsure about where to invest, consider the marginal tax rate you face now versus the one you expect to face upon retirement.  If the marginal tax rate you faced in 2010 is higher than the one you expect to face at retirement, it might be a good idea to invest in an RRSP.  If, however, the marginal tax rate you faced in 2010 is lower than the one you expect to face at retirement, think about investing in a TFSA instead.  Something else to consider is how flexible you want your money to be.  Your TFSA savings will always be accessible to you, penalty free, while the same is not true of an RRSP contribution.

As a dear friend once told me, I wonder if I should invest in RSVPs this year.  Hmmm.  I wonder indeed.

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2 Comments on “Uh oh: Your Finances”

  1. Cathy says:

    How can one find out about their marginal rate of taxation now compared to retirement age?

    • Sandra says:

      Unfortunately, you almost certainly can’t accurately predict what your marginal tax rate will be in 30 years. It will depend on your annual income in retirement (this includes RRSP withdrawals, Old Age Security if you qualify, pension, and other) and what the tax rate structure will be in your province at that time. You can estimate it or at least estimate it relative to your current marginal tax rate based on your current income and what you think your expenses, and thus income, will be at retirement. For example, if you’ve paid off your house by then, you and Evan may not need big incomes in retirement.
      My advice would be to keep some, but not all of your retirement savings in an RRSP, unless being penalized for withdrawals helps you save better.

      One more point of interest: over the last 10 years, tax rate levels have decreased in nearly every province. I can’t predict whether that trend will continue though.

      I hope that helped, Cath!


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