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With a year of no income, find out if it makes sense to max out registered accounts like an RRSP and a TFSA, and what other options investors may have.
I have $119,000 room allowed in my RRSP and $81,000 room in my TFSA.
I am 47, live in B.C., currently not earning income as a caregiver for a parent. I have a business with a registered GST number to claim income now or in the future. But for my question, let’s assume I will be claiming $0 for the next three years.
I have a sum of $250,000 coming to me as a gift, and I am looking to invest/save it.
I plan to use the portions not contributed into my TFSA and RRSP in investments that will be earning interest as income—likely mortgage investments.
Based on my income projections, what amount makes the most sense to invest into RRSPs at this time?
Should I spread the amount out over a period of time? Same question for TFSA.
—Jennifer
Jennifer, you likely want to maximize your tax-free savings account (TFSA), skip the registered retirement savings plan (RRSP) for now, and put the rest of your money into a non-registered account. However, the RRSP is worth considering. More on that later, but first let’s look at the differences between the two account types.
Right now, with no income, you’re living in a “tax-free world,” so to speak. If we were in the same situation there would be no need for TFSAs or RRSPs. And it wouldn’t matter if you earned interest, dividends or capital gains—none of it would be taxed.
Unfortunately that’s not the world we live in, and you’ll join the rest of us working, and you’ll be subject to tax, maybe in three years. And this brings us to your question: How to invest today to minimize your future tax liabilities?
Remember, when you add money to a TFSA and RRSP, you don’t pay tax on the growth while the funds are held in the account. When you draw money out of a TFSA it comes out tax free, and when you draw money out of an RRSP it is taxable.
The money invested in a TFSA is considered after-tax income, and money invested in an RRSP is considered pre-tax income. You get a tax deduction (refund) on an RRSP contribution but not with a TFSA. That is why you pay tax on an RRSP withdrawal (it was never taxed, and you were given a tax refund on the money) and no tax on a TFSA withdrawal.
The amount of tax you pay on an RRSP withdrawal is based on your total taxable income. The amount withdrawn from the RRSP is added to your other income for the year and then the amount of tax is assessed.
The obvious decision is to maximize a TFSA, which for you would be $81,000, assuming you already hold a TFSA, bringing you up to the $88,000 lifetime contribution limit. You will never pay tax on money in a TFSA. Same for the growth and withdrawals. It will be tax free, even when you have a taxable income.
In addition, each year you can make additional TFSA contributions, currently $6,500. The other advantage is creditor protection should someone sue you, if you can name a beneficiary, and the money doesn’t pass through your estate allowing you by-pass probate, if there is probate in your province of residence.
OK, that’s the easy decision.
Now, what to do with the remaining money?
The obvious thing is to pay down debt, if you have any, or add the money to a non-registered account.
You mentioned you would be investing in mortgages, which generates interest income. The full amount of the interest earned is added to your taxable income. This isn’t an issue when you have no taxable income, and the federal government lets you earn $15,000 before you pay any tax. The main thing to be aware of is that you will pay tax on the interest earned once you have a taxable income, meaning when you go back to work.
Going forward, each year you can draw money from the non-registered account and add money to your TFSA, while you have no taxable income. Until you earn a taxable income again, you might add money to both your TFSA and your RRSP. This will depend on the amount of your taxable income and the amount of RRSP money you plan to take to retirement. I’ll touch on this in a minute.
That was the simple and safest tax solution, but let’s go a little deeper.
You could add $119,000 to your RRSP giving you tax-sheltered growth, creditor protection and probate avoidance. By the way, in the big picture probate is not much money compared to the other taxes owing on an estate, so it is probably not worth putting money into an RRSP just for probate avoidance.
Here’s the issue: If you claim the RRSP contribution of $119,000 in the year you have no income, you will not get a tax refund because you didn’t pay any tax to be refunded. When you make withdrawals in retirement you will have to pay tax.
Do you see the risk? You could turn tax-free money into taxable money.
You have the option to not claim the RRSP deduction until you have a middle-class taxable income. Yes, you can do that. You don’t have to claim the RRSP deduction in the year you make an RRSP contribution, and the amount you can deduct in future years will be tracked on your notice of assessment. You don’t even have to claim it all in one year. You can claim the RRSP deduction over multiple years.
A couple more things to watch for if you are going to add the money to your RRSP now:
If not, or you are not sure, don’t add money to your RRSP yet.
If so, you may be better off without RRSP money in retirement. Instead you may consider having a combination of income from a TFSA and non-registered accounts. This keeps your taxes lower and helps to maximize government benefits and credits.
Finally, Jennifer, you could add about $45,000 to your RRSP now, not claim the contribution until you have some taxable income, and then draw out $15,000 over the next three years while you have no taxable income.
Check the territorial or provincial tax rates where you live, as you may take less than $15,000 without paying tax, although if you do the amount would be low.
You will have a withholding tax, but you’d get it back when you file your taxes. Doing this will allow you to get $45,000 out of your RRSP tax free or almost tax free. And then, at a future date, when you wish to reduce your taxable income, you may claim the RRSP contribution to get a tax refund on your $45,000 contribution, which may even help you qualify for the Guaranteed Income Supplement (GIS) in retirement.
Jennifer, these suggestions are to get you thinking about your options and are not meant to be taken as advice. Without knowing your current situation and what your future might look like, it is difficult to anticipate what your future tax rates might look like. And this is really a tax question.
Allan Norman provides fee-only certified financial planning services through Atlantis Financial Inc. and provides investment advisory services through Aligned Capital Partners Inc. (ACPI). ACPI is regulated by the Investment Industry Regulatory Organization of Canada (IIROC.ca). Allan can be reached at [email protected].
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