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By Julie Cazzin with Doug Robinson
Q: I’m 25 years old and have been able to maximize my 2022 tax-free savings account (TFSA), but what do I do now financially? What is the best investment route to pay the least amount of taxes for my future investments? The way I see it, I have two options: I could either start a registered retirement savings plan (RRSP) or a non-registered investment account.
I don’t earn a high income now and am in the first marginal tax bracket, so I don’t see a need to open an RRSP. However, I will start making $60,000 annually sometime next year when I switch to full-time work. I would like to buy a condo in three to five years and the RRSP has a benefit for that, even though paying back the amount within 15 years doesn’t appeal to me. What is the best option for me at this point? — Anthony
FP Answers: Anthony, a TFSA is a better choice than an RRSP when you are younger and earning a lower income. Once the TFSA is maximized, saving in a non-registered investment is better than the RRSP until you are in a higher tax bracket.
You are allowed to contribute to a TFSA every year from the age of 18 onward, assuming you are a resident of Canada. That means you have eight years of contribution limits that can be used, not just the current year’s limit. If you turned 18 in the year 2015, your lifetime contribution TFSA limit so far is $50,500. If you have not maximized the full lifetime amount, you should do this before starting non-registered savings.
Roughly speaking, income earned up to $50,000 is taxed at a lower rate (about 20 per cent), and income between $50,000 and $60,000 is taxed at a higher rate (about 30 per cent). Waiting until next year means the same RRSP contribution will save you more tax than it would this year.
Deciding when to start saving in your RRSP is more complex than this, but if using an RRSP will help you buy your principal residence sooner, then you should start contributing next year. Buying a principal residence is a wise goal and you can use the 30-per-cent tax savings to increase your down payment amount.
Once you have a principal residence, there is still a strong case for continuing to prioritize TFSA savings over your RRSP. That’s because you can take money out of a TFSA later and move it to your RRSP. For example, if you invest $10,000 in your TFSA, it grows tax free. If I assume it grows to $12,000, you can take out the full $12,000 and get a tax break on the principal and the $2,000 gain when you move it into an RRSP.
Most people don’t save and invest all their tax refunds from an RRSP, which makes building the TFSA smarter. If your income in the future exceeds $100,000, you will be in a much higher tax bracket (roughly 43 per cent), and this would be a good time to start moving some of your TFSA money into the RRSP and invest the resulting tax savings.
There are several government programs that will give you more money when your income is lower. Contributing to an RRSP has the impact of lowering your taxable income, which means benefits such as the GST/HST credit and Ontario trillium benefit are higher.
The most significant program is the Canada Child Benefit (CCB). If you are contemplating having a family, RRSP contributions will increase the CCB you are eligible for. This can be an excellent time to move savings from your non-registered account and TFSA into your RRSP.
Ideally, you will then use your tax refund and extra CCB to make a registered education savings plan (RESP) contribution for your child and get another 20-per-cent grant from the government for contributing to the RESP.
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The federal government has a handy online calculator to help you determine how much you can get in other benefits.
Anthony, since every situation is unique, I recommend you get some tax advice each year to guide your decisions.
In general, I suggest maximizing your lifetime TFSA limit, then putting your money into non-registered savings for the balance of this year. Next year, when you’re in the higher tax bracket, there is a good case to be made for putting enough into your RRSP to save on taxes and then use the tax refund to build your down payment.
Once you have a principal residence, using the TFSA and your non-registered accounts can again make sense until you have children, which is when the RRSP gains traction as your best option. Moving money from your non-registered accounts and then your TFSA into the RRSP is smart.
Doug Robinson is a certified financial planner and wealth adviser with Veritable Wealth Advisory in Peterborough, Ont. Veritable Wealth Advisory is a full-service financial planning and investment firm that employs multiple certified financial planners and portfolio managers with offices in Burlington, Kingston and Peterborough.
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