Author Topic: [CANADA] RRSP & TFSA vs tax brackets  (Read 1069 times)

BSL18

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[CANADA] RRSP & TFSA vs tax brackets
« on: September 28, 2018, 01:02:13 PM »
Hi everyone! Being an immigrant in Canada, I've always heard people talking about how a raise can send them to a higher tax bracket, and how investing in a RRSP can bring them down to a lower bracket, etc... Although as far as I know, no matter how much money you make the first bracket (43k$ QC 46k$ Fed) will always be taxed at the same level (and all the next ones as well).

So basically if in 2017 I made 41k$ I would pay 15% taxes. If I had a raise to 47k$, I would only pay 20/20.5% on respectively 4k and 1k (therefore only a 250$ difference due to the tax bracket). Is something wrong with my understanding?

And the following question would therefore be: is there any interest in saving in a RRSP particularly to get in a lower tax bracket, except the actual tax defferring on what you save, compared to saving within your tax bracket??

PoutineLover

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Re: [CANADA] RRSP & TFSA vs tax brackets
« Reply #1 on: September 28, 2018, 01:20:27 PM »
You are right that only the amount above the tax bracket jump is taxed at the higher rate. With an RRSP, you get tax savings now, but you pay the tax when you take out the money. If you put it in from the lowest bracket, you never save that much on taxes because when you take it out it'll be at least in that bracket, if not higher. So for low incomes, TFSA is better. You put in post tax money, but you never pay tax on it after that. Since you're putting it in from the lowest bracket, that's the minimum tax you can pay on it ever. That's my understanding at least, if someone knows better please correct me.
I think the optimal strategy is that while in the lowest bracket, max out your TFSA first, then contribute to your RRSP if you can. Although if you have pension match, get that first even though it comes out of your RRSP room, it's free money. Above that, contribute enough to get down to the lower bracket. If you have enough to max your TFSA and your RRSP, you're doing great. The important variables are your current income and tax bracket, and your expected income and tax bracket when you'll be withdrawing. If you expect to have higher income in retirement, I think you'll end up paying extra in taxes compared to the tax savings when you were stashing.

BSL18

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Re: [CANADA] RRSP & TFSA vs tax brackets
« Reply #2 on: September 28, 2018, 01:32:32 PM »
Right now I'm focusing more on catching up to my TFSA. I'm currently making roughly 67k/yr. I expect to be in this bracket for 5 to 8 years. I don't see myself FIRE before around 15 years. I am in my early 30s without kids (for now). Based on that, I figured I should rather boost my TFSA, and keep the RRSP room for when I reach the higher tax bracket or we another member join the family (whichever comes first) to bring my taxable income down at that point. Anything wrong with my reasoning?

PoutineLover

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Re: [CANADA] RRSP & TFSA vs tax brackets
« Reply #3 on: September 28, 2018, 01:38:23 PM »
Do you have a pension? How much are you currently saving and how much do you expect to spend in retirement? You're probably at a life stage where it's hard to know the answers long term if you expect to be adding family members and stuff. Saving in a TFSA is better than not saving at all so you're probably fine doing that for now and saving up the room for later. Do a case study if you want detailed answers, people are pretty helpful.

BSL18

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Re: [CANADA] RRSP & TFSA vs tax brackets
« Reply #4 on: September 28, 2018, 01:58:25 PM »
I do, contribution matched at 3%. Investment options from Desjardins suck though.

I actually did a case study a while ago, and I am figuring some things out to increase my savings rate (currently around 30% of take home pay). Expenses for the couple expected to be around 40k unajusted $ in retirement. I was planning to update it when settled but this TFSA vs RRSP question was bugging me so I figured I'd pick some brains around here. Also I live in a very rural area, so it is sometimes tough to relate to no-car walking-only cheap-grocery-store members of the forum, so I'll have to find a few ideas and answers by myself.

Retire-Canada

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Re: [CANADA] RRSP & TFSA vs tax brackets
« Reply #5 on: September 30, 2018, 06:44:58 PM »
So for low incomes, TFSA is better. You put in post tax money, but you never pay tax on it after that. Since you're putting it in from the lowest bracket, that's the minimum tax you can pay on it ever. That's my understanding at least, if someone knows better please correct me.

To understand if you are better off using the RRSP or TFSA you need to compare contribution and expected withdrawal marginal tax rates:

1. Higher marginal rate at contribution means a RRSP provides the same tax free return on post-tax dollars plus additional return due to the differential in marginal tax rates.
2. Equal marginal tax rates in and out then the RRSP and the TFSA are equivalent.
3. Lower marginal tax rate at contributions means a RRSP provides the same tax free return on post-tax dollars plus less a "penalty" return due to the differential in marginal tax rates.

If you can only fund one account I'd go with the RRSP in case #1. And the TFSA in cases #2 and #3.

If you can fund both I'd use both for cases #1 and #2. For case #3 I'd fund your TFSA and the fund a Non-Registered account.


BSL18

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Re: [CANADA] RRSP & TFSA vs tax brackets
« Reply #6 on: October 01, 2018, 07:06:01 AM »
Thanks for the detailed explanation. That's basically what I based my reasoning on. Knowing that I will most likely end up in a higher tax bracket at the end of my career than right now, whatever the expenses at FIRE (therefore retirement tax bracket) I stand a higher chance to belong to categories 1 & 2 if I start with the TFSA.

Back to the original question, what I understand is that no matter which tax bracket your salary puts you in, there is no huge advantage to lower your taxable income right below the threshold, you'll just end up increasing your returns on a few more $ (which is still nice), but increasing my saving to a couple hundreds of dollars a year is much more satisfying than verifying my T4 down to the last cent to make sure I am "in a lower tax bracket".

So for low incomes, TFSA is better. You put in post tax money, but you never pay tax on it after that. Since you're putting it in from the lowest bracket, that's the minimum tax you can pay on it ever. That's my understanding at least, if someone knows better please correct me.

To understand if you are better off using the RRSP or TFSA you need to compare contribution and expected withdrawal marginal tax rates:

1. Higher marginal rate at contribution means a RRSP provides the same tax free return on post-tax dollars plus additional return due to the differential in marginal tax rates.
2. Equal marginal tax rates in and out then the RRSP and the TFSA are equivalent.
3. Lower marginal tax rate at contributions means a RRSP provides the same tax free return on post-tax dollars plus less a "penalty" return due to the differential in marginal tax rates.

If you can only fund one account I'd go with the RRSP in case #1. And the TFSA in cases #2 and #3.

If you can fund both I'd use both for cases #1 and #2. For case #3 I'd fund your TFSA and the fund a Non-Registered account.