Have you been maxing out your Registered Retirement Saving Plan (RRSP) year after year?
It is a great way to maximize your tax deductions and ensure consistent savings for the future—but there are other options out there.
Contributing to your RRSPs is especially beneficial if you expect to be in a lower tax bracket in retirement than you are now. The tax deductions you’ll receive by contributing in that higher tax bracket will be of greater savings to you.
“Having all of your retirement income derived from your RRSP and other fully taxable sources can create a high tax bill in retirement and possibly affect other income sources,” said ATB Investor Services, Senior Solutions Analyst of Financial Planning, Linda Lamarche.
“Therefore, having some of your retirement income provided from the assets in a Tax-Free Savings Account (TFSA) would be beneficial as you can withdraw those assets tax-free.”
How to invest in TFSAs and RRSPs throughout your career and retirement
If you are in a lower tax bracket, contributions to a TFSA might make more sense for you. As long as you have room in your RRSP, the value of your TFSA can be transferred into an RRSP at a later date—like when you are in a higher tax bracket and could get a bigger bang for your buck. In the meantime, your assets in the TFSA will grow tax-free.
Early in your career, when your income and your marginal tax rate are likely to be lower, consider investing in a TFSA rather than an RRSP. In your mid-career, when your income is higher, investing in both a TFSA and RRSP can be beneficial, allowing for tax-free withdrawals at any time from your TFSA if you should need them. As you reach the late stages of your career your earnings will likely peak and be higher than your anticipated retirement income. Since your tax rate will be at it’s highest, it is advisable to invest in an RRSP at this time in order to defer taxes. If your RRSP contribution room has been used up, any excess savings can be invested in a TFSA.
Once you are in retirement, you may want to put additional savings into TFSAs. Most of your income sources, like income that comes from pension plans and Registered Retirement Income Funds (RRIFs), will be taxable. Also, since benefits like Old Age Security will be clawed back if your income is too high, it would be beneficial to receive some of your income from TFSAs. Income withdrawn from a TFSA is tax-free and will not affect income-tested benefits like Old Age Security. Learn more about Old Age Security and if it will be enough to help you retire.
If you continue to have a high income in the early years of retirement and are age 71 and under, or have a spouse age 71 and under, then RRSP contributions may be preferable to reduce that income as long as you have RRSP room. Remember that after age 71 your RRSP savings will be rolled into RRIFs and minimum withdrawals are mandatory. If you don’t need these funds to cover your living expenses, you can invest them back into a TFSA.
“Not everyone will fall into these straightforward categories, but the basic rules will hold true,” said Lamarche. “Early in your career when earnings and tax rates are low, invest in TFSAs. As earnings and tax rates peak, invest in RRSPs. As retirement begins, TFSAs are preferable unless income is likely to remain very high for a few years.”
Using non-registered investments for retirement savings
“Non-registered investment accounts are another vehicle that can be used to accumulate wealth for your retirement or other financial objectives,” said Lamarche. “A non-registered account can hold similar investments as a TFSA or RRSP and can often hold certain investments that would be prohibited in those accounts, like private small business shares for example.”
Unlike RRSPs, which provide tax-deferred growth, and TFSAs, which provide tax-free growth and tax-free withdrawals, earnings or growth in a non-registered account is taxable as it is earned. Income from non-registered investments are usually taxable in the year it is earned and how you are taxed depends on the type of income the investment produces. Income types depend on the specific investments in the non-registered account and can include dividends, capital gains or interest income.
“Some income types are more favourably taxed than others, so it’s important to ensure you have the right investment mix in your non-registered account,” said Lamarche.
Income you make on interest from your non-registered investments are fully taxable at your personal marginal tax rate, but only 50 per cent of any capital gains income is taxable. Dividends are taxed at a grossed-up amount and could give you a dividend tax credit if they come from Canadian sources, so they would be more tax-efficient than income produced by interest growth.
Unlike RRSPs and TFSAs, there are no limits to the amount that can be contributed to and accumulated in a non-registered account. If you are maxing out your tax-efficient RRSP and TFSA, additional wealth can be accumulated in a non-registered investment account.
When using non-registered accounts to invest for retirement, a number of factors need to be weighed and managed. These factors include your tolerance to risk, investment knowledge and your ability to monitor those investments. An ATB Financial Specialist can help you find the right balance with your investments in a non-registered account and can help you grow your wealth and be as tax-efficient as possible.
Are you ready to go beyond your RRSPs? Find expert advice by contacting an ATB Financial Specialist in your area.