Reader Case canadian

[milkman]

Hi im a canadian paying 40% tax on my imcome of 72000/year.  I have a defined benefit pension that will pay out approximately 40000/year when i turn 55.  im 28 now.  should i be investing in rrsps for the tax refund or tfsa?  My goal is to buy a house soon and retire at 55.

[Gerard]

Remember, your contributions to the DB pension plan reduce your RRSP contribution room -- probably by a lot -- so you can't contribute much anyway. You're actually paying 40% tax on only your highest slice of income, so I'd consider putting about that amount into the RRSP, if you're allowed to... build that up to $25K (and another $25K for the spouse, if you have one)... then pull that money out under the home buyer's plan, plus the tax refund, and use them to make a big enough down payment to avoid mortgage insurance (i.e., go for at least 20% down). I'm not sure how much else you need to save -- if you pay off the mortgage before you retire, $40K pension money should be plenty to live on (especially once CPP and OAS and seniors' tax deductions kick in at 65). If you build a big RRSP, you'd have to pay almost as much tax at withdrawal as you would now... and you might even get your OAS clawed back. So, short answer, after you've got your house down payment worked out, I'd put the rest into a TFSA, or just accelerate your mortgage payments.
Unless you live in Vancouver, in which case I'd continue to rent and spend the extra money on beer.

[Matt K]

I'm in a very similar position, same earning, similar defined pension (I'm government, and started at age 24, so my pension is ready to go at 55 sans penalty). I've just purchased my first house. I doubt I'm going to tell you anything you don't already know, but this has been my experience...

Firstly, you have about $3k/year of room in your RRSP so definitely be using all of that. You can take out $20k of that when you buy your first house ($25k? was it bumped up?). You have to pay it back within 15 years, but what ends up happening is you save $10k in interest over the life of your mortgage and your monthly payments stay the same, except $100/month is going back to you, not to the bank. Good freaking deal.

You also probably have a fair bit of room in your RRSP from before you started earning big bucks. I'm not certain on when RRSPs start based on age, but I know if you file income tax then they start then. So say you had a part time job when you were 18 (ten years ago). At that time your RRSP limit would have been $13k-$15k per year. Any of that you didn't use wasn't lost, it was deferred, so unless you've done a lot of investing in your RRSP, you still have a big back log of RRSP contribution you can use. So getting to the $20k point shouldn't be an issue of contribution room. And of course, that tax refund is mighty nice (Especially if you reinvest it in your RRSP right away). When I bought my house I left some money in my RRSP. I have two DRIP funds that are doing very well and I wanted to hold onto them and have my $100/m keep going into them. I'm not sure how much of that is sound financial sense, and how much is just irrational sense of wanting to keep holding them.

Your TFSA is limited to $5k per year, starting from the first year you opened it (so if you've had one for three years, you can have up to $15k in it, and if you only have $6k in it at the start of this year, you can contribute $9k this year). I didn't use my TFSA for my down payment or fees. I've got mine setup with ING, and I'm using it to save for some mid-term expenses I know I've got coming (buy out my car) and emergency fund.

I'm a public servant, and while I'm paying $450/month into my pension (why do all the public think my pension is "free"?) I'm not convinced it'll be paying out as well in 25 years as it says it will. Frankly it isn't sustainable as it currently stands and is far too easy a target for politicians. My goal is to pay down my house as much as possible (because it is a safe return and while it won't provide income will drastically reduce expenses), and then move hardcore into income earning investments (dividened funds are my poision of choice atm). For one thing, I want the freedom to leave the government and pursue other goals before 55 without being bound by my pension.

So now that I've rambled, to answer your question: Definitely max out your RRSP. Look at last years tax statement to find out what your actual contribution limit is, and aim for at least $20/25K in the RRSP. Reinvest the tax refund. Do that before contributing to the TFSA. However, make sure you at least open a TFSA so you can start building up contribution room in it. Enjoy Life.

That help any?

[SMC]

Matt, I'm pretty sure sure the TFSA limit of $5k/yr starts from 2009, not from when you opened it.  So if you open a TFSA now you would be able to contribute up to $20k right away.  I opened mine last yr and I already have $15k in it.

To the OP: If you are planning on saving for retirement, both the TFSA and RRSP are great.  If you google "tfsa vs rrsp" there are numerous breakdowns of which is a better retirement savings vehicle, however since it is impossible to know exactly how taxes will levied 30 yrs into the future it seems the best choice is to save in a combination of both, at least until your TFSA is full.  Ideally you would max out both by contributing $5k/yr to your TFSA + whatever the max contribution is to your RRSP (normally 18% of your income is the contribution cap, not sure how it works when you are paying into a pension).  If you still have more money to save on top of that it would have to be in a taxable account.

[milkman]

Ok thanks alot for the help!

[Matt K]

Matt, I'm pretty sure sure the TFSA limit of $5k/yr starts from 2009, not from when you opened it.  So if you open a TFSA now you would be able to contribute up to $20k right away.  I opened mine last yr and I already have $15k in it.

Good to know. When I read over the initial bill it was't clear to me; I'm happy to be wrong :)

[Gerard]

You can take out $20k of that when you buy your first house ($25k? was it bumped up?).

Yes, in 2009.

OP, listen to Matt, because he said it better than I did. The only thing I would be careful about is contributing so much to your RRSP in any given year that the tax rate ends up being the same as (or even lower than) you'll be paying in retirement. 40K pension + 10-12K CPP/OAS + (say) 10K earnings on investments puts you in the same tax bracket as you are now, and gets you mighty close to having your OAS clawed back.