Author Topic: Should I have a taxable account yet, or wait to max out my RRSP?  (Read 4271 times)

morning owl

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I'm a self employed canadian making around 30k/ year on average. I've maxed out my TFSA, and have made that a priority. I've held off on contributing to my rrsp for the past few years, because it's not that beneficial at my income level. I have about 50k of contribution room there.

My questions:

1. Should I be contributing to a taxable account or my rrsp, once my TFSA is maxed out? I've been contributing to the taxable because it's more accessible than the rrsp, in case I need to withdraw. I am not planning to RE, since I'm pretty much FI and doing what I want now part time, but there may be times when I'll need to supplement a slow year's income with investments, so I was thinking I'd access the TFSA and taxable first.

2. Am I wrong to think that I should leave the rrsp alone until I'm 71? (Currently 42, so there is a lot of time to let it grow.) This is another reason I haven't been contributing to it -- though I don't have tons of money in it, if it grows for 30 years then I don't want it to get out of hand, since I'll be paying tax on the withdrawals.

Any advice would be much appreciated!

Tanor85

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Re: Should I have a taxable account yet, or wait to max out my RRSP?
« Reply #1 on: June 01, 2015, 09:09:42 AM »
Hi,

here is my take on it:

If you think you that will eventually have a significantly higher salary, keep your RRSP contribution room. In your present situation, you would not obtain a very good tax return on your contributions. In fact, you may be paying more taxes at time of withdrawal if your annual withdrawals are higher than your current salary. Once your TFSA is maxed out, you can consider investing in Horizons' swap-based ETFs (HXT and HXS). These ETFs will shield you from capital gains taxes and dividend taxes until the day you sell them. They give you exposure to the US and Canadian market. Because of the tax advantage of these ETFs, you should hold them in a taxable account.  You can read more info about them on Moneysense.

Please note that I am not a professionnal advisor.

morning owl

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Re: Should I have a taxable account yet, or wait to max out my RRSP?
« Reply #2 on: June 01, 2015, 10:44:09 AM »
Thanks so much Tanor85 -- that was exactly my next question, what is the most tax efficient ETF to hold there. I will check out these articles!



Tanor85

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Retire-Canada

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Re: Should I have a taxable account yet, or wait to max out my RRSP?
« Reply #4 on: June 02, 2015, 08:39:55 AM »
My questions:

2. Am I wrong to think that I should leave the rrsp alone until I'm 71? (Currently 42, so there is a lot of time to let it grow.) This is another reason I haven't been contributing to it -- though I don't have tons of money in it, if it grows for 30 years then I don't want it to get out of hand, since I'll be paying tax on the withdrawals.

Any advice would be much appreciated!

Well there are pros and cons to letting the RRSP grow until you ar 71:

1. if it gets large you will be forced into large mandatory withdrawals you can't control
2. even if the RRSP is not crazy big you still have mandatory withdrawals that will affect you income and taxation
3. depending what benefits are available when you get to 71 some might be income tested which will be affected by RRSP withdrawals so you may pay this extra "tax" as well as your normal marginal tax rate
4. All RRSP $$ are taxed as income so you miss out on some of the beneficial tax rates on capital gains and some dividends.
5. there are some tax treaty benefits if you hold US based ETF with US stocks
6. you can pull money out penalty free before 71 so you do have flexibility when you withdraw if you income fluctuates

I think the only way to get a handle on this is to put together a spreadsheet for your finances that allows you to wargame a bunch of investment options vs. the tax impacts.

-- Vik

Al1961

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Re: Should I have a taxable account yet, or wait to max out my RRSP?
« Reply #5 on: June 02, 2015, 09:17:52 AM »
[quote author=morning owl link=topic=38063.msg680389#msg680389

*snip*

I think the only way to get a handle on this is to put together a spreadsheet for your finances that allows you to wargame a bunch of investment options vs. the tax impacts.

-- Vik

This.

Timing of withdrawals is the important variable in this kind of analysis. Sequence of return will likely change the result a bit, but you can't know in what direction - it may be best to deal with only the one variable.

Just a couple of days ago I finished this kind of analysis on withdrawing LIRA funds. Age 71 does not look like the optimal time for me to begin withdrawals.

Age 62 seems to minimize the nominal tax burden, but age 71 maximized total nominal income. I do need to go back and convert the nominal amounts to PVs before making a decision.

Al

MrMoneyPinch

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Re: Should I have a taxable account yet, or wait to max out my RRSP?
« Reply #6 on: June 02, 2015, 04:27:58 PM »

I'm a self employed canadian making around 30k/ year on average. I've maxed out my TFSA, and have made that a priority. I've held off on contributing to my rrsp for the past few years, because it's not that beneficial at my income level. I have about 50k of contribution room there.

My questions:

1. Should I be contributing to a taxable account or my rrsp, once my TFSA is maxed out? I've been contributing to the taxable because it's more accessible than the rrsp, in case I need to withdraw. I am not planning to RE, since I'm pretty much FI and doing what I want now part time, but there may be times when I'll need to supplement a slow year's income with investments, so I was thinking I'd access the TFSA and taxable first.

2. Am I wrong to think that I should leave the rrsp alone until I'm 71? (Currently 42, so there is a lot of time to let it grow.) This is another reason I haven't been contributing to it -- though I don't have tons of money in it, if it grows for 30 years then I don't want it to get out of hand, since I'll be paying tax on the withdrawals.

Any advice would be much appreciated!

Don't cut your nose just to spite your face. 

You are right in that TFSA > RRSP at low incomes, but RRSP > taxable anytime.  In fact, in very rich circles the advice is to max both, then look at deferring income using a corp;  but that's inefficient under 128k$ of regular income.

I don't understand why people are so scared to get their OAS+GIS clawed back;  that's (at most!) 16k per year, if you are alone and destitute.  To me, it's like stopping to work just to prevent from getting "your" welfare benefit cut.

At 30k$, you are pretty close to zero effective tax rates (check for your province's number).  An RRSP deposit could take you there.  On the other hand, taxable investments' income will be added to your income EVERY YEAR, which will create a tax load which eats some of your employment income.  Moreover, paid taxes are compounded just like investment returns:  all paid tax dollars cannot be invested, and produce no returns, those missed returns produce no returns themselves, etc, etc.

Also, RRSP's are great for people having irregular incomes:  you deduct all deposits from your income on a good year, and withdraw some of them back in bad years, lowering your average lifetime tax rate.  RRSP's can be withdrawn at any time without penalties (except if your investments or brokerage charges some), you only add them to your income for the year.   That's also true for ER: you certainly could withdraw from your RRSP from your first "retired" fiscal year without losing a cent to the tax man - keep the annual withdrawal under the "zero tax" number and make up the missing spend with TFSA withdrawals.

If you want to know more, read "Money road" from Garth Turner.  He's an ex-cabinet minister in charge of the CRA, so he knows a thing or two about taxes.  That book was written before the TFSA, but the rest is still good.

Note: I am not a tax accountant, fiscal planner or responsible for your choices. 

Hummer

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Re: Should I have a taxable account yet, or wait to max out my RRSP?
« Reply #7 on: June 02, 2015, 10:03:46 PM »
Hi,

here is my take on it:

If you think you that will eventually have a significantly higher salary, keep your RRSP contribution room. In your present situation, you would not obtain a very good tax return on your contributions. In fact, you may be paying more taxes at time of withdrawal if your annual withdrawals are higher than your current salary. Once your TFSA is maxed out, you can consider investing in Horizons' swap-based ETFs (HXT and HXS). These ETFs will shield you from capital gains taxes and dividend taxes until the day you sell them. They give you exposure to the US and Canadian market. Because of the tax advantage of these ETFs, you should hold them in a taxable account.  You can read more info about them on Moneysense.

Please note that I am not a professionnal advisor.

This is correct. Since you are below the minimum income tax level there is basically no point in contributing to an RRSP. You will not get a tax return unless you are above the minimum tax bracket ~$39,000? I believe.

Here is a breakdown of the basic different accounts.

TFSA - no tax return for using it.                                                                           However, all moneys grow tax free within it.
RRSP - tax return in the form of reducing your taxable income                              However, growth is taxed once you withdraw the money, this is different than the TFSA
taxable account - no tax return                                                                              All growth is taxed similar to the RRSP.

You have done the right thing using the TFSA first. I foresee at some point in your future, your income rising above the minimum tax bracket, once that happens, use the RRSP but only use it to the lowest tax bracket to maximize your tax return each year.

For example, Lets say you earn $45k and the lowest tax bracket is $40k. You are able to live on $20k, so you will invest $25k each year. Here's what you want to do.
Contribute $5k to the RRSP. That effectively brings your taxable income down to $40k. Contributing more won't be advantageous to you since you will not get a tax return for any money under the $40k  tax bracket. Then contribute $10k to the TFSA each year since the government recently changed the contribution room to $10k. Then contribute another $10k to your taxable account. This way each year you would contribute $25k to your investment portfolio using $5k to the RRSP, $10k to the TFSA and $10k to the taxable account. This will maximize your returns.

Cheers

morning owl

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Re: Should I have a taxable account yet, or wait to max out my RRSP?
« Reply #8 on: June 03, 2015, 06:15:59 AM »
Thanks for the feedback, everyone. Curious about these spreadsheet analyses... I am a spreadsheet fanatic but have never done this sort of calculation as there are just so many unknown variables in the future. My income is highly irregular, and who knows what will happen with the markets!

MrMoneyPinch, initially I was investing primarily in individual dividend stocks (!), until reading more about why this is not the wisest approach on this forum. I had read elsewhere (G&M article, I think) that since certain Canadian dividend stocks were eligible for a dividend credit, this allows individuals to potentially earn up to 50k a year in dividends (provided that this is their only income) tax-free. I don't intend to earn that much in earnings & dividend income combined, so I thought that moving my dividend stocks over to the taxable account would be a good plan of action. Meanwhile I could build ETF positions in my tax-sheltered accounts. (Currently most of my RRSP is in individual US stocks, and now, VTI. TFSA is mostly Cdn dividends, and now, some VDU.)

The TFSA is maxed for this year, and I'm building up another 10k to put in Jan 1 2016. I'm keeping this all in a 'high interest' savings account in the meantime.

I've just started putting away funds in the taxable account. I might have to do some shifting around once I figure out what the most tax-efficient options are.


For example, Lets say you earn $45k and the lowest tax bracket is $40k. You are able to live on $20k, so you will invest $25k each year. Here's what you want to do.
Contribute $5k to the RRSP. That effectively brings your taxable income down to $40k. Contributing more won't be advantageous to you since you will not get a tax return for any money under the $40k  tax bracket. Then contribute $10k to the TFSA each year since the government recently changed the contribution room to $10k. Then contribute another $10k to your taxable account. This way each year you would contribute $25k to your investment portfolio using $5k to the RRSP, $10k to the TFSA and $10k to the taxable account. This will maximize your returns.

Cheers

Bingo, thank you Hummer, this makes total sense. Since I'm already in the lowest tax bracket I won't really be saving much by investing in my RRSP, so I'll hold off until I do hit a year when I earn a bit more. Thank you for clarifying this!

I think what it all comes down to is: it's tough to plan for FIRE with an irregular income. I think this gives me a really good rule of thumb though: max out TFSA first, and if my income that year is over the lowest tax bracket cutoff, I'll throw everything else into my RRSP; otherwise, it goes into taxable.


Heckler

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Re: Should I have a taxable account yet, or wait to max out my RRSP?
« Reply #9 on: June 03, 2015, 07:41:45 AM »
I just skimmed your journal. Correct me if I'm wrong.


-own house, mortgage free
-married, husband with enough income to pay off a HCOL city mortgage.
-your TFSA is maxed, but you are investing in taxable instead of RRSP
-combined finances of a happily married couple

So, I assume hubby is also maxing out TFSA and RRSP?

If he is, and you both have extra to invest, you need to open a spousal RRSP, so that he can contribute to your RRSP contribution room, reducing his taxes today and evening out each of your RRSP incomes at retirement.   By increasing your a RRSP income (and taxes), you can reduce his RRSP income (and taxes), instead of living solely off his RRSP at a higher tax rate during retirement.


Forget about a taxable account till both TFSAs and RRSPs are maxed. Ideally he can set up a spousal through his work plan, and contribute pretax dollars.

This was the biggest piece of advice we followed from our Sunlife financial adviser my company provided free of cost. 

http://www.cra-arc.gc.ca/tx/ndvdls/tpcs/rrsp-reer/cntrbtng/spsl-eng.html

« Last Edit: June 03, 2015, 08:00:08 AM by Heckler »

morning owl

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Re: Should I have a taxable account yet, or wait to max out my RRSP?
« Reply #10 on: June 03, 2015, 08:25:41 AM »
Hi Heckler, thanks for the thought.. But from what I understood, and quickly reading the CRA link above, the spousal RRSP limits are determined by the contributing spouse, are they not? So in our case, yes, my husband maxes out his rrsp and TFSA, so he has no more contribution room. I didn't think he could use MY contribution room for a spousal rrsp, can he?

Retire-Canada

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Re: Should I have a taxable account yet, or wait to max out my RRSP?
« Reply #11 on: June 03, 2015, 08:31:04 AM »
Thanks for the feedback, everyone. Curious about these spreadsheet analyses... I am a spreadsheet fanatic but have never done this sort of calculation as there are just so many unknown variables in the future. My income is highly irregular, and who knows what will happen with the markets!

While this is true your it doesn't mean conducting an analysis of the possibilities isn't useful. You just have to be aware that a plan made in 2015 on what we know now will need to be updated. Personally I think once a year is often enough to crunch numbers and make changes.

As each year rolls by you can compare how reality is matching up with your projections and if they diverge a great deal you take action to align them.

The nice thing about a properly setup spreadsheet is that you can punch in various values for scenarios and see what the results are likely to be.

- try worst case [low income, low return from investments]
- try best case [high income, high return]
- average case

In my case I'm concerned my RRSP will be too big when I am 71 and I'll be forced into high mandatory withdrawals so I am projecting what the future value of my RRSP will likely be based on expected contributions and historical average market returns. If I hit five 20%+ return years in a row at the start my RRSP will a lot different than if I hit five 20%+ return years at the end even if the average return over the period is the same. That doesn't stop me from planning based on say a 7% after inflation return. I'll just adjust how I manage my RRSP when I see what each year's actual returns are.

Heckler

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Re: Should I have a taxable account yet, or wait to max out my RRSP?
« Reply #12 on: June 03, 2015, 09:05:30 AM »
Hi Heckler, thanks for the thought.. But from what I understood, and quickly reading the CRA link above, the spousal RRSP limits are determined by the contributing spouse, are they not? So in our case, yes, my husband maxes out his rrsp and TFSA, so he has no more contribution room. I didn't think he could use MY contribution room for a spousal rrsp, can he?

Doh! It appears I've misunderstood the limits rules.  Thanks for pointing this out. We won't have this problem till two years from now anyway. 



The income balancing still applies though, especially to you two.

http://turbotax.intuit.ca/tax-resources/spousal-rrsp.jsp


Any other advantages to spousal RRSP contributions?

They allow for income balancing if you make more money than your spouse. In Canada, couples that have equal income basically receive double the tax deductions. Spousal RRSPs are a way for couples to split retirement income. The money you put into an RRSP is allowed to grow tax deferred. That means you do not pay income tax on it until you take it out of the plan.

If only one spouse has a large amount of money in an RRSP, at retirement that will mean a high income and paying more income tax than if each spouse has the same amount divided between their RRSPs. Both spouses would then be in a lower tax bracket and pay income tax at the same lower marginal tax rate.


morning owl

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Re: Should I have a taxable account yet, or wait to max out my RRSP?
« Reply #13 on: June 03, 2015, 10:09:30 AM »
Vikb -- thanks for the ideas, I will try out some charts to see what the scenarios might be.

Heckler -- happy to help, haha!

In terms of income splitting, there are better rules in Canada for those over 65 -- RRSP income can be split between a retired couple.

In our case we don't really need the spousal RRSP because our RRSP amounts are fairly level. Partly due to the fact I had a high income too at one point, and partly because I'm the better investor ;)

(Joking. Sort of. Haha.)

SK Joyous

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Re: Should I have a taxable account yet, or wait to max out my RRSP?
« Reply #14 on: June 03, 2015, 04:35:59 PM »
Hi morning owl,

You've received a variety of good answers here, with the result being either put into RRSPs to reduce tax now (and defer to later) or use taxable accounts; I think this is personal preference at this point, based on your own personal projected income in the future.  I did want to give the links to these two Canadian Couch Potato articles on the most tax efficient ways to invest in taxable accounts (there are others, but these are a good overview)

http://canadiancouchpotato.com/2014/09/30/after-tax-returns-on-canadian-etfs/

http://canadiancouchpotato.com/2012/09/20/foreign-withholding-tax-which-fund-goes-where/