THUNDER BAY – Business – Now that we’re in RRSP season, retirement plans and tax efficiency are on the tops of many people’s minds. When comparing RRSPs (Registered Retirement Savings Plans) and TSFAs (Tax Free Savings Accounts), taxation is certainly most important. If not used correctly, taxation can significantly alter the value of an individual’s financial portfolio and affect their ability to reach their long-term goals. There is also the importance of starting early, and keeping up, to further accelerate growth. Every individual is unique, so there is a need to recognize that every situation is different and therefore it is important to determine which solution is right for you.
Making the case for RRSPs – Accelerate growth, curb taxes
Starting RRSP contributions early puts time and money on your side. Let’s use an example to make a case:
Investor A starts investing $2500 per year for 40 years, and let’s assumes him or her averages a 4 percent rate of return over the course of that period. The individual would need to start investing in RRSPs before the age of 30. The value of his or her portfolio would be $247,066 at the time he or she would need to start withdrawing the money.
Investor B starts investing $5000 per year for 20 years, and we’ll assume him or her averages the same 4 percent rate of return over the course of that period. The value of his or her portfolio would be $154,846 at the time he or she would start withdrawing the money.
Investor A and Investor B both contributed the same amount of money, and both averaged the same rate of return, yet even still Investor A has 60% more money in his or her portfolio. As you can see, there are tremendous advantages in starting an RRSP early in life, thanks to the power of compounding growth.
RRSP or TSFA – Which one to consider first?
Individuals should also know that RRSPs aren’t the only way to save for retirement in a tax-efficient way. TSFAs if used correctly can fit into a retirement planning strategy in conjunction with RRSPs. You may struggle to know which one to start first, but the challenge is to understand which one would provide the greater tax benefit. The answer to that question will depend on your current tax rate.
TFSAs will provide more tax benefits if the tax rate is expected to be higher at the time of withdrawing the money, compared to the tax rate when the contribution was first made. When an individual’s tax rate when they make the contribution is the same as what they expect it to be when they’re to redeem the money, a TSFA and RRSP have equal benefit. In this scenario, other factors should be considered such as the need for tax refunds, as well as the contribution amount. However, if the individual expects their tax rate to be lower when withdrawing the funds, they should consider an RRSP before a TSFA.
The Bottom Line
Starting to make your contributions early can be difficult, but developing a strategy for the long term is necessary. Use the help of a financial advisor to start a plan that meets your long term goals, and provides you with the right options. You can never start contributing too early, but it’s better to start late than to not start at all.
Anthony M. Talarico
Financial Security Advisor
W: 807.343.4788 ext. 248 C: 807.472.6092
anthony.talarico@freedom55financial.com
www.freedom55financial.com
