Karey Irwin, CFP
Vice President, Investment Funds
As the RRSP deadline of March 2 approaches, many investors are reviewing their portfolios and strategies, but with the Tax Free Savings Account (TFSA), investors have another place to put their funds.
In a perfect world, all investors would contribute the maximum allowance every January for their RRSP (18 per cent of your income to a maximum of $24,270 for the 2014 tax year) and TFSAs ($5,500 per year). But the high cost of living in many areas and limited resources mean that most investors need to choose where to place their hard-earned investment dollars.
One’s age has an impact on how to make these decisions. Let’s look at a few life stages and the best retirement savings approach:
Late career investors
These investors are usually focused on saving. As the retirement date closes in, many confront difficult choices if they haven’t saved enough. Although they are saving aggressively now, they are concerned with whether they have enough to retire comfortably. At this point, the RRSP is a useful tool. The tax benefit is high, since investors are at peak income levels. In many cities, the ability to live on government pensions is low so they are motivated to make RRSP contributions.
These investors are often focused on paying off their mortgages and saving for children’s education rather than saving for their own retirement. While debt reduction is important, the benefit of tax-sheltered growth should not be overlooked. In addition to a current-year tax deduction, “time in the market” (i.e. the length of time funds are invested) can be very important in terms of potential for capital appreciation. Postponing saving for retirement until after the mortgage is paid off can be risky—not only can you run out of time to save enough capital, but for many people, the discipline of saving can be harder when there are other options for consumption. Funds previously dedicated to mortgage payments now can be used for holidays or more personally rewarding options like “new toys” rather than “saving for retirement.”
For these people, the RRSP decision is more complicated. Early in a career, retirement seems a lifetime away and is not top of mind. The focus is often on debt repayment and home ownership. Investing in an RRSP can be useful as a way to build capital on a tax-deferred basis and receive a tax deduction in the current year. If one of the objectives is saving for a home, up to $25,000 of your RRSP capital can be withdrawn under the Home Buyers Plan for first-time homeowners without attracting tax (but will need to be repaid over 15 years). That means a couple can use $50,000 of their RRSPs toward their first home.
The TFSA may be a more attractive option for young investors. While it doesn’t provide an immediate tax credit, it provides tax-sheltered growth and allows for tax-free withdrawal of capital and any capital gains, along with re-contribution of the withdrawn amounts in future years. Unused RRSP and TFSA contribution room carries forward to future years so the benefit is still there if it’s not used in the current tax year.
The solution for many can be to invest in both. Contribute to your RRSP on a regular basis (say, monthly) and use the tax refund to pay down your mortgage. Contributing to your RRSP throughout the year rather than with a lump-sum purchase the last week of February has many benefits: automatic savings helps with cash flow management and it’s less painful than having to find money for your contribution in February. In addition, by contributing throughout the year, you can benefit from dollar-cost averaging by buying more units of mutual funds when markets are down and fewer when markets are up.
Regardless of age or phase of life, saving for your retirement should not be put on the back-burner. A financial advisor can often help assess the best savings strategy for your stage in life and financial goals. Regardless of the approach, getting into the habit of regular savings, whether to an RRSP or TFSA, should be part of every Canadian’s life.
This article is not intended to provide advice, recommendations or offers to buy or sell any product or service. The info provided in this article is compiled from our own research and is based on assumptions that we believe to be reasonable, accurate at the time the report was written, but, is subject to change without notice.