Using algebra to decide between TFSAs vs. RRSPs for retirement planning
- Thread starter herlings
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juliajulia123
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resjudicata
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@stormannorman Yeah Snap Projections gets the job done.
@resjudicata Anyway for a DIYer to get access to that? I've been seeing it on YouTube and it looks sweet.
resjudicata
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@herlings There’s a very fundamental qualitative consideration missing from the discussion.
If you are younger and need to withdraw money earlier for expenses before you are in a low income tax bracket - TFSA is more advantageous. Once you withdraw from an RRSP you never get that contribution room back. TFSA contribution room is returned the following year of a withdrawal.
If you’re 18 years old - you have a lots of time and expenses standing between you and retirement and will need money to those things too
If you are younger and need to withdraw money earlier for expenses before you are in a low income tax bracket - TFSA is more advantageous. Once you withdraw from an RRSP you never get that contribution room back. TFSA contribution room is returned the following year of a withdrawal.
If you’re 18 years old - you have a lots of time and expenses standing between you and retirement and will need money to those things too
mattinelmira
New member
@resjudicata Another qualitative factor: TFSA is not protected from creditors in the event of bankruptcy. RRSPs are. Do with that info what you will.
@herlings lol
I did a similar analysis years ago:
It's all about the withdraw tax rate vs contribution tax rate. If it's lower when withdrawing, the RRSP is better. If you are getting CCB the RRSP is even better.
RRSP FV = PV(1 + r)^n × (1 - tw)
TFSA FV = PV(1 - tr) x (1+r)^n
where r = rate of return, n = periods, tc/tw = tax rate on contribution and withdrawal
If your PV is 50k at 7% over 20 years, the RRSP will be worth 155k vs the TFSA at 116K, a 33% difference, assuming 40% tc and 20% tw. Note: PV for the TFSA is discounted by your tax rate since we're assuming after-tax dollars
The difference can be simplified to: (1 - tw) - (1 - tc) / (1 - tc) so at 40/20%
it would be (.8 - .6) / .6 = .33
One huge advantage of the TFSA is that you can take a lump sum anytime and there is no estate tax
You could also retire early and withdraw a good portion of your RRSP tax free. For a couple they could take out 30k per year at current personal amounts!
I did a similar analysis years ago:
It's all about the withdraw tax rate vs contribution tax rate. If it's lower when withdrawing, the RRSP is better. If you are getting CCB the RRSP is even better.
RRSP FV = PV(1 + r)^n × (1 - tw)
TFSA FV = PV(1 - tr) x (1+r)^n
where r = rate of return, n = periods, tc/tw = tax rate on contribution and withdrawal
If your PV is 50k at 7% over 20 years, the RRSP will be worth 155k vs the TFSA at 116K, a 33% difference, assuming 40% tc and 20% tw. Note: PV for the TFSA is discounted by your tax rate since we're assuming after-tax dollars
The difference can be simplified to: (1 - tw) - (1 - tc) / (1 - tc) so at 40/20%
it would be (.8 - .6) / .6 = .33
One huge advantage of the TFSA is that you can take a lump sum anytime and there is no estate tax
You could also retire early and withdraw a good portion of your RRSP tax free. For a couple they could take out 30k per year at current personal amounts!
@kkamagwi The part that I've been trying to solve is whether to defer the RRSP deduction vs. to defer the RRSP contribution entirely. I wanted to find an analytic solution in terms of the five variables (g, g*, m, tm, tn), but I couldn't reduce the expressions any further. Still stuck with testing numeric solutions only, sigh.
heavenandearth
New member
@mst86 That exact sentence though does give two specific scenarios where RRSP with delayed-deduction could be worthwhile. Interestingly I started researching this because we were left with this choice this year as my wife had a low income year due to maternity leave, with several months of RRSP contributions into the company matched RRSP program, and an expected return to higher income in 1 year. This made delay deduction the correct choice since taxable account is not an option.
@heavenandearth Yes I suppose if there's another reason to have contributed to an RRSP (match) it could make it worth it.
@herlings The timeframe for that particular problem is short enough that regardless of what those 5 variables are, short-term market fluctuations will be the ultimate decider on which will outperform.
For example, in a downturn in the 2 years that you decided to defer the deduction, the RRSP may outperform a non-registered simply because your exposure to the market is smaller.
So any analytical solutions to reduce further than the 5 variables are likely moot. As with most things RRSP, it depends a lot on personal financial situation and outlook - like you mentioned with CCB, OAS, etc.
For example, in a downturn in the 2 years that you decided to defer the deduction, the RRSP may outperform a non-registered simply because your exposure to the market is smaller.
So any analytical solutions to reduce further than the 5 variables are likely moot. As with most things RRSP, it depends a lot on personal financial situation and outlook - like you mentioned with CCB, OAS, etc.
@herlings Here's my ELI5: RRSP is great, TFSA is a bit better for most people. Unless you are a very high earner and expect to withdraw much less when retired, TFSA usually wins out.
This is true in the abstract mathematical sense, but in reality there are complications.
First, TFSA has more flexibility. If there is a dire emergency and you need the money, TFSA can be used without any tax liability and the contribution room comes back next year. RRSP money would be taxed at your marginal tax rate and the contribution room is gone for good.
Second, RRSPs can only be as good or better than TFSAs if you contribute the up front tax savings that the RRSP gets you back into to the RRSP. e.g. You can contribute $3000 after tax dollars in a year and are in a 33% tax bracket. If $3000 is deposited into a TFSA, you are done. If it is deposited into an RRSP, you will get a $1000 back in taxes, which MUST be reinvested to have any chance of beating a TFSA. In fact, you should deposit $4500 into the RRSP and get a $1500 refund to make it a net deposit of $3000. In reality, a lot of people only put $3000 into the RRSP and spend the return on other things.
Third is the potentially very high average tax rate when withdrawing in retirement. OAS and GIS are income dependent, and RRSP/RRIF withdrawal count as income. when in the income bracket where the OAS or GIS is being clawed back, the marginal tax rate is over 50%. When combined with CPP income that's also taxable, RRSP withdrawals can put seniors in a terrible average tax rate from an income tax perspective. And it cannot be avoided indefinitely, because RRSPs need to be converted to a RRIF when you are 71 and are forced withdraw it. TFSA money can be withdrawn (or not) at any time without any tax implications.
Fourth is inheritance. If someone dies and does not have a living spouse or financially dependent child or grand-child to transfer the RRSP to, then the RRSP will be taxed in its entirety, which might be a higher tax bracket than the person ever had while alive. A TFSA is transferred without a tax burden.
IMHO, first max out any employer match, then max out TFSA, then max out RRSP. I would put away as much as you can asap, unless you KNOW that you will make a lot more in the next 5 years. You might give up a small, future differential in a tax return, but you will stay on track to save. There are many, many people in their older years with $100,000+ RRSP contribution room that has constantly grown over the years.
This is true in the abstract mathematical sense, but in reality there are complications.
First, TFSA has more flexibility. If there is a dire emergency and you need the money, TFSA can be used without any tax liability and the contribution room comes back next year. RRSP money would be taxed at your marginal tax rate and the contribution room is gone for good.
Second, RRSPs can only be as good or better than TFSAs if you contribute the up front tax savings that the RRSP gets you back into to the RRSP. e.g. You can contribute $3000 after tax dollars in a year and are in a 33% tax bracket. If $3000 is deposited into a TFSA, you are done. If it is deposited into an RRSP, you will get a $1000 back in taxes, which MUST be reinvested to have any chance of beating a TFSA. In fact, you should deposit $4500 into the RRSP and get a $1500 refund to make it a net deposit of $3000. In reality, a lot of people only put $3000 into the RRSP and spend the return on other things.
Third is the potentially very high average tax rate when withdrawing in retirement. OAS and GIS are income dependent, and RRSP/RRIF withdrawal count as income. when in the income bracket where the OAS or GIS is being clawed back, the marginal tax rate is over 50%. When combined with CPP income that's also taxable, RRSP withdrawals can put seniors in a terrible average tax rate from an income tax perspective. And it cannot be avoided indefinitely, because RRSPs need to be converted to a RRIF when you are 71 and are forced withdraw it. TFSA money can be withdrawn (or not) at any time without any tax implications.
Fourth is inheritance. If someone dies and does not have a living spouse or financially dependent child or grand-child to transfer the RRSP to, then the RRSP will be taxed in its entirety, which might be a higher tax bracket than the person ever had while alive. A TFSA is transferred without a tax burden.
IMHO, first max out any employer match, then max out TFSA, then max out RRSP. I would put away as much as you can asap, unless you KNOW that you will make a lot more in the next 5 years. You might give up a small, future differential in a tax return, but you will stay on track to save. There are many, many people in their older years with $100,000+ RRSP contribution room that has constantly grown over the years.