It seems everyone’s talking TFSAs these days, especially given the increased annual dollar limit of $6,000. That increase brought the cumulative limit up to $63,500 for clients who were at least 18 years of age in 2009 and resident of Canada throughout that period.
But with all the attention given to TFSAs, it’s important that clients don’t neglect its less sexy cousin – the traditional RRSP. Here are three reasons why RRSPs may still be the ideal retirement savings choice for many Canadians.
RRSPs first, TFSAs second
Clients who anticipate being in a lower tax bracket in their retirement years should prioritize their RRSP contribution over a TFSA. They may even consider withdrawing funds on a tax-free basis from a TFSA and contributing the proceeds to their RRSP. They could then re-contribute the amount to their TFSA in a later year once their RRSP contributions are maximized and additional cash becomes available.
In addition, clients who are making accelerated payments on their mortgage should consider whether making RRSP contributions might be a better use of their cash. RRSPs may be a better option than paying down debt when the rate of return on RRSP investments is expected to be greater than the rate of interest on debt. This is especially true of lower-rate mortgages, where the interest rate may still be in the 3% range.
RRSPs provide some flexibility
While it’s true that a TFSA offers the ultimate in flexibility — in that funds can be withdrawn at any time and for any reason — we should remind clients that RRSP funds can also be tapped to buy a first home or to go back to school.
The Home Buyers’ Plan (HBP) allows individuals to withdraw up to $25,000 from their RRSP to purchase or construct a first home. A spouse (or partner) may also be able to withdraw $25,000, for a combined total of $50,000.
Amounts withdrawn under the HBP must be repaid over a maximum of 15 years, or the amount not repaid in a year is added to the client’s income for that year. There are no penalties for returning HBP funds to an RRSP before the required repayment date, so early repayment allows participants to continue to maximize the tax benefits from investing within an RRSP as soon as the cash becomes available.
Under the Lifelong Learning Plan (LLP), individuals can withdraw up to $10,000 per year, or $20,000 in total, to finance full-time education for themselves or a spouse. If both withdraw funds, a total of $40,000 would be available over two years. To qualify, the student must be enrolled in a qualifying educational institution. Most Canadian universities and colleges and many foreign educational institutions will qualify.
Amounts withdrawn under the LLP must be repaid over a 10-year period, starting five years after the first withdrawal or two years after ceasing studies, whichever is earlier. There are no penalties for returning LLP funds to an RRSP before the required repayment dates, so early repayment allows taxpayers to continue to maximize the tax benefits from investing within an RRSP as soon as possible.
RRSPs allow income-splitting in retirement
Finally, remember that RRSPs can provide couples with a great way to income-split upon retirement. Spousal RRSPs can be set up in which the high-income spouse contributes (and gets the tax deduction) to an RRSP for the lower-income spouse. In retirement, RRSP withdrawals can be taxed in the hands of the lower-income spouse.
Even without spousal RRSPs, the pension income-splitting rules allow RRSP funds to be transferred to a registered retirement income fund (RRIF) and, once the annuitant is at least 65 years old, those RRIF withdrawals qualify to be split, up to 50%, with a spouse.
These two retirement income-splitting techniques can minimize the amount of tax a couple might pay on their retirement savings.