TIL - If your tax rate at contribution and withdrawal is the same, your take home from pretax RRSP contribution is the same as TFSA at withdrawal

[melsha]

I learned this recently so thought I'd share it with people.

If you make pretax contributions to a RRSP - via your payroll - you end up with the same take home as your post tax contributions to a TFSA if your tax rate at contribution and withdrawal is the same.

If your tax rate is lower at withdrawal then RRSP will come out ahead of TFSA.

If your tax rate is higher at withdrawal then TFSA will come out ahead of RRSP.

In all scenario's both beat out non registered.

For the examples below:

• Let us assume you have 10K in PRETAX money to contribute.
• Let us assume you get a growth of 100% in 10 years and withdraw the full amount after those 10 years.

RRSP is the same as TFSA​

Contribution Tax Rate: 30%

Withdrawal Tax Rate: 30%

Line Items
RRSP
TFSA
Non Registered

(a) Pretax Contribution
$10,000
N/A
N/A

(b) Post Tax Contribution
N/A
$7,000
$7,000

(c) Income Tax Paid on Contribution: 30% of 10K
$0
$3,000
$3,000

(d) Value after 10 years: 100% of (a) or (b)
$20,000
$14,000
$14,000

(e) Capital Gains
$10,000
$7,000
$7,000

(f) Taxable Amount on Withdrawal
$20,000 - 100% of (d)
$0 - Tax Free
$3,500 - 50% of (e)

(g) Income Tax Paid on Withdrawal: 30% of (f)
$6,000
$0
$1,050

(h) Total Tax Paid: (c) plus (g)
$6,000
$3,000
$4,050

(i) Total Take Home: (d) minus (g)
$14,000
$14,000
$12,950

This math only works on PRETAX contributions to RRSP such as via payroll.

For POST TAX contributions to RRSP, which trigger a return from the CRA, you need to reinvest the return into your RRSP. However, TFSA could come out slightly ahead in this case depending on how much growth you get from reinvesting the return at a later time.

RRSP comes out ahead of TFSA​

Contribution Tax Rate: 30%

Withdrawal Tax Rate: 25%

Line Items
RRSP
TFSA
Non Registered

(a) Pretax Contribution
$10,000
N/A
N/A

(b) Post Tax Contribution
N/A
$7,000
$7,000

(c) Income Tax Paid on Contribution: 30% of 10K
$0
$3,000
$3,000

(d) Value after 10 years: 100% of (a) or (b)
$20,000
$14,000
$14,000

(e) Capital Gains
$10,000
$7,000
$7,000

(f) Taxable Amount on Withdrawal
$20,000 - 100% of (d)
$0 - Tax Free
$3,500 - 50% of (e)

(g) Income Tax Paid on Withdrawal: 25% of (f)
$5,000
$0
$875

(h) Total Tax Paid: (c) plus (g)
$5,000
$3,000
$3875

(i) Total Take Home: (d) minus (g)
$15,000
$14,000
$13,125

Ideally most of us should be aiming to be in this scenario. It is after all the main selling point of RRSP. Contribute at higher tax rate. Withdraw at lower tax rate.

TFSA comes out ahead of RRSP​

Contribution Tax Rate: 30%

Withdrawal Tax Rate: 35%

Line Items
RRSP
TFSA
Non Registered

(a) Pretax Contribution
$10,000
N/A
N/A

(b) Post Tax Contribution
N/A
$7,000
$7,000

(c) Income Tax Paid on Contribution: 30% of 10K
$0
$3,000
$3,000

(d) Value after 10 years: 100% of (a) or (b)
$20,000
$14,000
$14,000

(e) Capital Gains
$10,000
$7,000
$7,000

(f) Taxable Amount on Withdrawal
$20,000 - 100% of (d)
$0 - Tax Free
$3,500 - 50% of (e)

(g) Income Tax Paid on Withdrawal: 35% of (f)
$7,000
$0
$1,225

(h) Total Tax Paid: (c) plus (g)
$7,000
$3,000
$4,225

(i) Total Take Home: (d) minus (g)
$13,000
$14,000
$12,775

Yes I posted this last night, however, I tried to make an edit based on some suggestions in the comments and Reddit with its new interface decided to mess up all the charts. Too lazy to fix it last night. So I deleted the post and fixed it up this morning.

 

[dracma]

@melsha It's also important to factor in how your marginal tax rate will vary over your working years. If you're expecting your income to grow over your career, you will want to delay RRSP contributions until you're in your higher earning years to maximize the tax rate differential. How/when you make these contributions is of course a personal choice.

 

[rbcooprs01]

@dracma Couldn’t you contribute to your RSP and then delay the tax deductible portion until a future year?

 

[hannahbraaksma]

@rbcooprs01 You can do exactly that, but you're usually better off claiming and investing the tax credit than claiming it in a future year. (Unless your income is dramatically increasing in the near future).

 

[tumrub]

@rbcooprs01 You can, but aside from the employer RRSP matching, you will literally never come out ahead by delaying the deduction. Literally never. It’s always better to take an immediate deduction, or use a non-reg account temporarily, then switch to RRSP with an immediate deduction.

 

[rbcooprs01]

@tumrub Thanks! I had forgotten about the non-reg account temporarily option.

Just curious though, say you swap jobs half way through the year, could the interest in the non-reg account be taxed at a higher tax bracket depending on your salary increase/when you started?

But it must be pretty close regardless at that point.

 

[sportfishingjunkie]

@dracma Yes, but this ignores the cost of delaying the return. This paper on the topic discusses whether you should contribute and delay the returns: https://papers.ssrn.com/sol3/papers.cfm?abstract\_id=3240046. For most reasonable delays, it might be better to actually use a non-registered account, but for longer time horizons it is often worth actually just taking the smaller return now so you can start growing that money sooner.

 

[markymarc]

@sportfishingjunkie You can use both a TFSA & an RRSP at different points in your career.

When you're starting out and expect your income/marginal tax rate to increase max out your TFSA's to start growing that money and when you're at the peak income phase of your career/life switch to the RRSP.

 

[mckenna]

@sportfishingjunkie Your link is broken, remove the

\

in it.

 

[sportfishingjunkie]

@mckenna It seems to work for me and I don't see a \ ?

 

[fedor]

@sportfishingjunkie right after "abstract", it's "%5C" in the browser after you click it if you are looking there.

 

[sportfishingjunkie]

@fedor Huh. Might depend on the Reddit client. Doesn't happen for me :/

 

[mckenna]

@sportfishingjunkie You're right, I see it on old.reddit.com, not on reddit.com.

 

[joannsak]

@melsha Estate planning is also an important consideration. If you are in a position to have some assets left behind after death, a TFSA passes to your beneficiaries tax-free, whereas your RRSP balance is taxed as if it was all withdrawn at death. Depending on one’s situation, this can be a significant factor in favour of TFSAs.

 

[michaeleric]

@joannsak The RRSP isn't taxed if it passes on to your spouse. I'm sure you're aware, but expanding on this for anyone who is reading.

 

[joannsak]

@michaeleric Correct, that is the one exception. It’s more of a deferral, as upon the spouse’s death, the tax implications are the same as stated above

 

[michaeleric]

@joannsak RRSP can also roll-over on a tax-deferred basis to a disabled child as well.

 

[sandrachenlau]

@joannsak Gotta make sure I die on Jan 1 to minimize taxes

 

[broword]

@joannsak Most people are not aware of the dirty little secret the banks and the government never mention about RRSP/RRIF's. That a great many people die with six figure balances remaining and get taxed at nearly 50% on their final tax returns. Usually at a tax rate much higher than the refund tax rate on initial contribution. They usually run out of time trying to decumulate a large RRSP/RRIF account still earning investment income.

 

[bandyadelaja]

@broword "Oh no, I had too much money when I died" is a great problem to have. May we all be so lucky.