I’ve written about choosing between a TFSA or RRSP in the past but I thought I would share a real case study on someone I recently met.
Richard is 32 years of age. He is married with one four-year-old son.
He is putting away $300 per pay into 3 different accounts at the bank.
- $100 per pay into RRSPs
- $100 per pay into TFSAs
- $100 per month into RESP
Is this the right mix?
When deciding which account to invest, the starting point is deciding what you are saving for. After a brief discussion, Richard concluded that the RRSP money was for retirement, the TFSA was like an emergency fund and the RESP was for his son’s education.
Optimize RRSPs first
In Richard’s case, he was making about $116,000 per year in the Northwest Territories. His marginal tax rate is about 38% so any money he puts towards RRSPs gives him a really great tax deduction. Given this high tax savings, any money going into RRSPs will give him the best immediate bang for his buck.
Related Article: The proper use of RRSPs: the one formula approach
From a purely numbers perspective, the RRSP gives a better initial ‘return’ than the TFSA and RESP. Does that mean he should redirect the entire $300 per pay to the RRSP and not contribute to the TFSA and the RESP? Not necessarily!
RESPs are still good
Numbers are important but there’s more to this decision than just numbers. Contributing to RESPs means Richard gets a government grant called the Canada Education Savings Grant (CESG), which is worth 20% of every dollar contributed.
Related article: The ins and outs of RESPs
Although that’s lower than the 38% he would get in tax savings for the RRSP, the purpose of the money is completely different. The RRSP is for his retirement where the RESP is for his son’s education. The decision is less about math and more about purpose and priorities.
What about the TFSA?
In Richard’s case, he has good cashflow but having an emergency fund is never a bad thing. Richard currently has $12,500 in the TFSA that he does not need or plan to touch anytime soon and was wondering if he should leave it in the TFSA or move it to the RRSPs?
The answer again depends on what the money is for. If Richard does not need the TFSA for spending or emergencies then switching it over to RRSPs gives him a pretty good bang for his buck. Let’s look at the math:
If Richard moves $10,000 of the $12,500 to RRSPs, he will get a $3800 tax refund in May after he files his 2012 tax return. He can then take the $3800 and add it to the $2500 left behind in the TFSA for a total of $6300. He was comfortable with having $6300 in the TFSA. Richard also decided that he would keep $50 per month going into he TFSA and redirect the other $50 to the RRSP.
Related article: TFSA or RRSP – Why not do both?
By moving some of the money to the RRSP, it allowed him take advantage of a bigger tax refund and based on the time of year, the TFSA would not be depleted for a long period of time.
This example represents a planning opportunity for those people who have money in their TFSAs and have not maximized their RRSP. Take a look at your marginal tax rate and if you don’t need the money to stay in TFSAs, you may benefit in moving some of the TFSA to the RRSP to get a tax deduction on the money.
What would you do if you were in this situation – TFSA or RRSP?