The only thing to remember is that you want capital gains in your TFSA, and interest in your RRSP/RDSP.
The reason being that only 50% of capital gains are taxable in Canada, but if they are in your RRSP they are 100% taxable (when you withdraw them).
Good luck opening up the accounts!
That's not true, is it? Growth is growth, you'll be taxed on it just the same. I mean, if you could choose, you'd have your TFSA have all the growth and the RRSP none. The point of the shelter is that there is NO tax on the money while sheltered.
Sadly it's true - I'm just going to take a sidebar here on semantics...
Registered Accounts, such as RRSP's and RDSP's are called tax 'deferral' mechanisms. It's not a true 'shelter' - you get a tax 'benefit' now, but the tax 'output' later is generally higher (thanks to growth, income, etc.) The point being, you get a deduction at your marginal rate today, but you will pay your marginal rate on withdrawal (hopefully it's lower).
The TFSA is a half-measured tax shelter (a true shelter has you invest pre-tax income, at very low rates of taxes in the future)... The caveat with a TFSA is that it is after-tax income.
Capital gains (or growth, as you say) are taxed at 50%. When invested in a registered account and deferred, will be taxed at 100%.
As a case study - Note, this is ONLY for capital gains purposes.
You invest $100,000 in your RRSP in all growth stocks, and receive a sizable refund of $30,000 (i.e. 30% rate) this year. This grows over time, and let's assume you're Warren Buffett and it appreciates by $1 million by retirement. You'll now pay your marginal rate on the entire $1.1 million dollar balance. Assuming this is at 25%, this is $275,000 in tax!
Total offset is plus 30k today, minus 275 in the future... Let's call it $245k and ignore present valuing...
If you invested it all in just a regular investment account - only the gain is taxable... 1 million gain, 500k taxable capital gain... At the same marginal rate (25%), that's $125,000 in TOTAL tax. You're investing "after-tax" dollars here however... So we'll add back the 30% on the original investment, and say you've paid an additional 30K in taxes. So... $155,000.
In a TFSA (assuming the same scenario... which is impossible at the moment...) you'd just have paid the initial tax on your employment income (i.e.. the 30k) and nothing thereafter...
The TFSA is clearly best... But note that the present value of the current tax refund would need to be 90k higher to break even... Quadrupling is not out of the question, but it is challenging, and would likely take at least 15-20 years to get there. (see: rule of 72 http://en.wikipedia.org/wiki/Rule_of_72).
Hope this helps to de-mystify a bit! Le Barbu is 100% correct - TFSA is a shelter, once it's in, never taxed again
This is not a fair way to compare the TFSA and RRSP. The correct way to compare them is to assume that the 30% "refund" you received from investing into the RRSP was also itself invested into the RRSP. If you model it that way, you will discover that the TFSA and RRSP are exactly equivalent iff your initial and final marginal rate is the same. The only difference is that the TFSA is the superior instrument if your terminal marginal rate will be higher. The RRSP is the superior instrument if your terminal marginal rate will be lower.
The only other thing that's not equivalent is the contribution room rules, which could matter for some people, but ignoring that, the instruments are basically mirror images of each other when correctly compared.
Here's the formal proof:
Using the notation as follows:
x : amount of after-tax dollars to be invested
t : years until retirement
r : rate of return per year, assume annual compounding without loss of generality
a : marginal rate for any additional income now
b : marginal rate for any additional income at retirement
If you invest x into a TFSA, the value of the TFSA at retirement is x*(1+r)**t.
If you invest x/(1-a) into an RRSP (equivalent to x after-tax dollars), the value of the RRSP at retirement after taxes is (1-b)*(x/(1-a))*(1+r)**t.
So the value of the RRSP will exceed the value of the TFSA if and only if (1-b)/(1-a)>1 which is equivalent to a>b, or the original claim stated above, namely that the marginal rate for any additional income now exceeds the marginal rate for any additional income at retirement.
Long story short, for most people on these forums, the RRSP is better than the TFSA if you have room in both, regardless of what you intend to put inside the accounts.
If you intend to retire MMM-style early, RRSP will beat taxable accounts as well, because you will be paying approximately 0% tax at withdrawal (keeping in mind that some of the 4% rule can just be return of principal while you are extracting the contents of the RRSP), so the recharacterisation of capital gains as ordinary income does not hurt you. (If you intend for a more princely retirement, taxable accounts can beat RRSPs in some cases.)
US readers will recognise this is very similar to the situation in the USA except in Canada, you don't need workarounds like the "roth pipeline" because the RRSP allows withdrawing at any time. Indeed, moving to Canada is another way to extract the contents of your US 401(k) or IRA (known in Canada respectively as a "foreign pension plan" and a "foreign retirement arrangement") before the defined ages, because the Income Tax Act allows the contents of those plans to be rolled over into a Canadian RRSP without using any of your RRSP room (subject to some conditions). I may end up benefiting from this if I move back to Canada in the future.
Thanks for your response here. It brings up some interesting points.
I wish tax were as simple as your formula presented here - if it were the case I'd be writing this from a beach in the Caribbean (after I patented the equation), rather than the frigid and cloudy land of Canada.
You're correct - my case study was not an accurate reflection of RRSP vs. TFSA - however, it was perfectly accurate in the case of RRSP vs. TFSA in the case of Capital Gains, which was stated up front.
Rather than going through everything - I would like to point out a few errors in your calculation here -
The first being that, if you're withdrawing from an RRSP, you will most certainly be taxed. Returns of Capital in an RRSP are taxable, at your full marginal rate.
Secondly, the comment regarding Mustachianism and withdrawing from an RRSP are patently false - namely the comment that you can live on this income and be taxed at zero percent. If you plan to retire early (as many of us do) and withdraw from your RRSP, you have around $10,000 in withdrawals from an RRSP before getting taxed. If you think $10,000 is enough to live on for a year in Canada (or $20K as two people), I've got some great land to sell you up north that will make you rich... $10k a year in retirement does not a prince make. Plus - this discussion becomes moot once CPP and OAS kick in, which will eat up this room, meaning that your RRSP will now be taxed at a minimum of approximately 20% (not that different from my example, as you'll note).
The last, and biggest logical flaw here I think extends from the fact that my example was purely a capital gains one (for demonstration purposes) rather than a pure RRSP vs. TFSA comparison.
In your example - you state that so long as the marginal rate at retirement is less than the marginal rate today, the RRSP is a better option (in that, when a > b, the RRSP is better). This is a big over-simplification and skews the original question, which was regarding capital gains in these accounts.
In Canada, capital gains are only half-taxable... meaning that you're dealing with a marginal rate on capital gains that is half of what you'd deal with in an RRSP (ceteris paribus). Your equation doesn't factor this in, and treats all income as equally taxable (when they are not. Capital gains, dividends, and interest are all taxed at different rates - outside of RRSP's, where you are taxed at 100% for everything).
This means that your marginal rate today, needs to be significantly higher than in retirement.
To demonstrate, I'll change the figures - same gain, registered vs. non registered. You invest $100k, plus, since you're a high income earner, let's say 50% of that is a tax refund - so you get $150k in total investment.
I'll do the same - but in after-tax dollars... So I effectively "lose" 50k in this example from the start.
Even at the LOWEST possible brackets - you'll be taxed $200,000 (oops. $220,000 - you're taxed on the total amount... this is the only edit...)on your withdrawals (20% up to around 55k per year... accounting for the personal credit etc.). I'll be taxed at 10% - so $100,000. You got $50k up front, but I get $50k more (nominally speaking... not going to deal with PV, as stated, on this one).
There is no example here, where you don't lose in a nominal sense, other than around zero percent (which is fictitious in Canada - see part regarding land for sale above). The only time this breaks even is when the marginal rate is around 10%, ignoring time value of money. The marginal rate in retirement with CPP and OAS will be twice as high, i.e. 20%.
In short - the RRSP is a loser when it comes to capital gains.
Cathy isn't necessarily incorrect in her formula for interest, but with dividends it is more complex, and capital gains is even further. The story here is that in an RRSP you defer income until withdrawal, in a normal account they're triggered upon receipt (i.e. buy/sell stocks, receive dividends etc.) and in a TFSA any gains are not taxable. To say they are the same is to say dogs and fish are the same because they are both animals - in real life, they are entirely different, and very much depend on your situation.
I encourage specificity here, because in tax you need to know everything (age, marital status, expected retirement age, etc etc etc) to figure out what's right for YOU. Generalities are great to demonstrate a point, but are ultimately unrealistic in life. The point being - if you have $10,000 to invest in stocks and bonds, you're better to put the stocks in a TFSA, and the bonds in an RRSP. Growth is great - but you want to avoid double taxation in the case of capital gains in RRSPs.
Also - I wanted to add a caveat to your statement regarding US transfers to Canada. The US-Canada tax treaty is a complicated one - the US taxes on citizenship, and Canada of residency. (i.e. you always file in the US if you're a citizen - which is not the case in Canada. We can retain citizenship, move to the Cayman Islands, and say 'neener neener' to the CRA)
. If you're looking to transfer a 401k or IRA to Canada (RRSP and TFSA, respectively) I would HIGHLY
recommend you speak with a qualified CPA (in Canada) who is experienced in these international tax issues - The rules are weird, residency based (in Canada), and definitely ones you want someone who deals with these issues constantly to look at (i.e. not me, who gets a snapshot on a blog... but someone who will go into much more detail). You want to ensure you do it right the first time.