Investing

TFSA vs RRSP - Where to invest from?

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  • Jul 4th, 2020 10:54 pm
[OP]
Deal Addict
Aug 22, 2009
1507 posts
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TFSA vs RRSP - Where to invest from?

I have been doing some research and I was wondering about USA stocks.

One YT channel I follow mentioned putting them into RRSP because you only pay tax on them when you withdraw. Most people during retirement have a sharp decline in income therefore the taxes are less.

In the TFSA the USA stocks are taxed.

What if you have a really good Government pension how does this all fit together?

We were told years ago not to do RRSP because we will fall into a high tax bracket when we retire based off our pensions. So..... how do I determine TFSA vs RRSP when it comes to these USA stocks?
7 replies
Deal Fanatic
Jul 1, 2007
8431 posts
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You're asking a lot of different things which are best answered by a complete financial plan.
Money Smarts Blog wrote: I agree with the previous posters, especially Thalo. {And} Thalo's advice is spot on.
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Feb 1, 2012
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Thunder Bay, ON
First of all the primary difference between TFSA and RRSP is when you pay the tax on your income. With a TFSA you earn income, you pay income tax on it, deposit money in a TFSA, then there is no tax when you withdraw. With a RRSP, you earn income, you don't pay income tax on it (either in the form of a tax refund, or no tax deducted if you contribute to an workplace group RRSP), then when you withdraw you pay tax on it as income. So effectively you have never paid income tax on the money in your RRSP, and because of that part of your RRSP belongs to the government, at your marginal tax rate when you withdraw.

If your marginal tax rate is the same when you withdraw as when you contributed, then RRSP and TFSA are approximately equal. If your tax rate is lower when you contribute, then TFSA is better. If your tax rate is lower when you withdraw, then RRSP is better. That's why it is often recommended to max your TFSA when young and your income is low, then switch to RRSP contributions when your income is higher. Many, if not most people will have lower income, therefore lower tax rate when retired.

If you have a full public service pension with 35 years service, then your pension (including bridge pension / CPP) will be 70% of your final salary. Say OAS adds another 5 to 10% then you get to retirement income 75% to 80% of working income. So if you have a RRIF and your mandatory withdrawals push your retirement income above your working income, then your retirement tax rate could be higher. Plus if your income gets above $79,000 then your OAS will start to get clawed back at the rate of 15 cents per dollar above that threshold, and it's all clawed back by about $128k of income. If you expect your retirement income to be within those thresholds you need to look carefully to estimate your retirement tax rate vs your working tax rate to see if RRSP is still a good deal. I find www.taxtips.ca to be a good resource. sorry no definitive answer, but it depends on each individual's situation.

Re tax on US holdings in a TFSA. Yes, most countries including USA impose a non-resident tax of about 15% on dividends. But the US has a special exemption for retirement accounts. RRSP, RRIF, LIRA etc qualify as retirement accounts but TFSA does not. So if you have both RRSP and TFSA then hold the US stocks in the RRSP. Note that exemption only applies to stocks or funds that trade on a US exchange like NYSE or NASDAQ. A fund trading on the TSX that holds US stocks (like XUS or VUN) will not get the withholding tax waiver. The withholding tax rate is 15%, and say the dividend yield of the S&P500 is 2% and 40% of your portfolio is US stocks then the impact is .15 x .02 x .4 = .0012 or a total impact of 0.12% annually. Not a really big deal. You can run the numbers for your own holdings.
I solemnly swear, to never assume I have an inkling at which direction the market will head, and to never make any investments based on a timing strategy.
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May 11, 2014
4019 posts
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HI OP;
So you are getting just snippets of investing strategies without understanding the full detail of what is going on.
You are not getting "taxed" on the investment in US stocks.

What occurs is if you are paid a dividend from a US stock, you are taxed a 15% dividend withholding tax by the US IRS (assuming you fill your W-8 form from the brokerage). In the Canada-US Tax treaty, they waive this 15% tax on US dividends in RRSP accounts. This is where having US stocks in an RRSP might be beneficial because the dividends are kept intact.

In a non-registered account, you pay this withholding tax, however you can claim a foreign tax credit on your income tax return so even though you pay 15% of the dividends to the US government, the Canadian government allows you to reduce your taxes by the same amount, effectively making the effect neutral.

In a TFSA, because the Canada-US Tax treaty doesn't cover TFSAs, the dividend withholding tax applies. However, (stupid imo) because the TFSA is considered tax-free, the CRA doesn't allow you to claim foreign tax paid, because "you shouldn't have to pay taxes in a TFSA." Stupid imo.

So if you own US shares that pay dividends, it might be worthwhile to hold it in an RRSP compared to a TFSA. However, what I caution people is do not make this a rule. This should only be a suggestion. Not all stocks pay a dividend for starters, and when you withdraw your stocks from an RRSP, the extra gains become taxable income in the end. In a TFSA, those gains are tax free. While dividends are a big part of return, so is capital gains. If anything, what you should focus mostly on is the growth of your funds. Where you allocate them can be important, but not the focus.

The suggestion about not putting money into an RRSP when you have a pension is also not an absolute. It depends on your situation. For instance, if you decide to retire early, an RRSP may be more beneficial because you have many years to spread out your withdraws, lowering your overall annual income per year when you withdraw making it more beneficial than your TFSA. So the real answer depends on how much your pension will be and how you plan to spend the funds during retirement. TFSAs are often better in most cases because it is much more flexible and being able to build a tax-free income source is very valuable if you do have the pension.

I will give you an example of how the RRSP situation can be beneficial. Suppose you earn an average $50000 salary in Ontario. If you work for 35 years in a pension plan, your approximate pension might be say $35000 at 65 (70% of the income) Say at 65 your RRSP account is worth $300000. So you have $35000 in pension income and say you evenly withdraw your RRSP over 20 years. meaning you withdraw approximately $15000 a year. This makes your income approximately $50000 per year.
https://www.taxtips.ca/taxrates/on.htm

That makes your pre-retirement and post-retirement tax rate approximately the same, topping out at around 29.65% (note: it is a bit more complicated with tax credits etc. but we are looking big picture). In this case, there isn't a lot of benefit other than an RRSP contribution can improve cash flow with your tax return. There is a risk though. Say at age 70 you were to suddenly pass away, the approximate $200000 left in the RRSP is fully taxable on your estate meaning, your final tax return for your heirs means that $200000 will be taxed at the higher 48.19% which can cost more in taxes.

But say you wanted to retire early. Say in the above example, you retire at 55. Your pension might be now $25000 per year, and your RRSP is now $200000. Let's say you don't withdraw your RRSP until age 65. At age 65, the funds grow to $300000. At age 65, you do similar like above and withdraw over 20 years. Now your taxable income is approximately 40k. Your tax bracket tops at 20.05% which is less than 29.65% giving you a tax benefit to using an RRSP.

So see it shouldn't be a fix rule whether you use an RRSP vs a TFSA. First look at your estimated pension value and decide from there. I would say if you really aren't sure, TFSA is probably going to be best. If you provide numbers, we could look at what you may consider.

The true answer should be to maximize both :P

edited: I need to proof-read :facepalm:
Last edited by xgbsSS on Jul 1st, 2020 9:36 am, edited 2 times in total.
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[OP]
Deal Addict
Aug 22, 2009
1507 posts
1163 upvotes
Wow. I have a lot more to learn. Thanks a lot for all the information
Deal Addict
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Feb 1, 2012
1349 posts
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Thunder Bay, ON
Easto wrote: Wow. I have a lot more to learn. Thanks a lot for all the information
Remember the search for a perfect plan is the enemy of a good plan. Don't neglect regular saving and investing while you learn the fine points.
I solemnly swear, to never assume I have an inkling at which direction the market will head, and to never make any investments based on a timing strategy.
Deal Fanatic
Jul 1, 2007
8431 posts
1466 upvotes
Thalo wrote: You're asking a lot of different things which are best answered by a complete financial plan.
Or, just wait till one or both of the people who keep replying in essay-format comes here. Smiling Face With Open Mouth And Smiling Eyes
Money Smarts Blog wrote: I agree with the previous posters, especially Thalo. {And} Thalo's advice is spot on.
Deal Addict
Oct 23, 2017
1596 posts
1172 upvotes
GTA West
Regarding the RRSP vs the TFSA, keep in mind that after the RRSP is converted to a RRIF (mandatory) the RRIF withdrawals qualify for income splitting. This can result in a very significant income tax reduction if your spouse has a much lower income. So you really do need to see the whole picture or hire someone who can.

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