An example may help put this concept into context. Say, you had $10,000 to contribute to either a TFSA or an RRSP. If you contribute the full amount to a TFSA, and it grows at 5% per year, it would be worth $16,289 after 10 years. You could withdraw it, pay no tax and spend that $16,289.
By comparison, if you contribute that $10,000 to an RRSP and you’re in a 30% tax bracket, you get your investment plus a $3,000 tax refund, which means you come out ahead initially. If we assume you contribute that $3,000 to a TFSA, and it grows at 5% per year for 10 years, you would have $16,289 in the RRSP and $4,887 in a TFSA a decade later.
At first, the RRSP seems like a better outcome. However, if you are also in a 30% tax bracket when taking the RRSP withdrawal, you would only have $11,402 after tax. Combined with a withdrawal of the $4,887 tax-free from the TFSA, you have the same $16,289 to spend as if you had contributed the whole $10,000 to the TFSA in the first place.
Project your income in retirement
Most people end up in a lower tax bracket once they retire, but not everyone does, Kate. People with a low income prior to retiring may be more likely to remain in the same bracket.
So, for your situation, it may be that your spouse should contribute to their RRSP, but you should not contribute to yours, for example. You must try to project your future income, while also taking into account other retirement income sources, like Canada Pension Plan (CPP) and Old Age Security (OAS).
If one of you dies at an early age, the survivor may be in a higher tax bracket with all income taxed on one tax return. And if your future incomes are approaching the OAS clawback limit—$90,997 in 2024 for OAS recipients—that can push up your effective tax rate on RRSP withdrawals up by 15%.
An OAS recipient can be paying more than 55% marginal tax in retirement (or over 62% tax in Quebec). This is higher than a working age taxpayer earning millions.
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Contribute to registered accounts with caution
So, the moral of the story, Kate, is to contribute with caution. The spousal RRSP idea might be a good one for your higher-income spouse. If they have a lot of RRSP room, consider deducting the contribution over a couple of years.
As a senior I’m now realizing putting money in a TFSA is the way to go. We’re taxed to the hilt.
Another consideration is if one of the spouses is required to go into a care facility. These facilities will take 80%+ of the individuals income. Having the taxable income split equally at the source will help to reduce these fees. For example, if only one spouse has the rrsp and that spouse ends up in care, there would need to be a significant withdrawals even with income splitting to afford the remaining spouse the same cash flow to support the household. Having their own rrsp funds allows them to minimize the funds that need to be withdrawn by the spouse in care, preserving some of the wealth and allowing the remaining spouse to plan for lifestyle.
I do both , butI also have non registered investments for emergencies.
Thank you for this comprehensive reply and information. Very helpful. It sounds like we need to consider different factors such as current and projected retirement income, tax brackets, and goals, before choosing what to do with this money. A large portion is parked in TFSAs until we can figure out what might be the better options. My spouse’s income will decrease for a few years before retirement, which might also affect choices. Thanks for the informative reply.
We are taxed too much on our land holdings