Ashleay: Welcome to our “In Your Interest” podcast. My name is Ashleay. Today, we’re in luck – we have two guests to chat about a seasonal topic: RRSPs. Our specialists will tell you how to optimize your tax refund. With us are Sébastien Mc Mahon, our Chief Strategist and Senior Economist, and Pierre Lafontaine, Director, Financial and Tax Advanced Solutions at iA Financial Group. Hello Pierre, hello Sébastien.
Sébastien: Hello, Ashleay.
Ashleay: Pierre, let’s start with a basic question. What’s the difference between RRSPs and TFSAs?
Pierre: The major difference between RRSPs and TFSAs is their tax implications. An RRSP offers a tax deduction when you contribute to it, and withdrawals – at retirement or before – are taxable. With TFSAs, there is no upfront tax break, hence no deduction when you contribute to it. However, you pay no tax on withdrawals or on growth within the account. What is similar is that both accounts provide tax-sheltered growth, which helps you reach your savings objectives faster and grow your accounts more effectively. Both accounts also allow you to carry forward any unused contribution. If you don’t make the maximum contribution this year, you have opportunities to catch up in future years.
Sébastien: When you invest in an RRSP or a TFSA, you can use the same investment strategies. You can buy individual stocks or mutual funds. In that respect, there is no difference between the two, right?
Pierre: Yes. Actually, you can select any investment products you like as long as they can be applied within an RRSP or a TFSA.
Sébastien: Okay, so your choice of products really depends on your investment horizon.
Sébastien: What are the rules of thumb for choosing between RRSPs and TFSAs?
Pierre: Generally, RRSPs are better suited to high-income earners who want to save for their retirement. You can also use RRSPs to purchase your first home or further your education. TFSAs provide benefits to medium to lower-income earners and people who are saving for short-term goals like a vacation or home renovation. Basically, choosing between the two depends on your goals and lifestyle.
Sébastien: So the key factors in your decision are your stage in life, age, marital status, and whether you have children.
Pierre: Yes, exactly.
Sébastien: Based on your experience, is it always clear whether an RRSP or a TFSA is the appropriate choice?
Pierre: Yes. Let’s take as an example a young person in her twenties or thirties with average income who wants to build an emergency fund or save for travel. A TFSA would be the appropriate choice. She can withdraw money at any time, which wouldn’t be considered income, which is especially beneficial if she’s still employed.
Sébastien: In that example, the investor has a shorter time horizon. That’s why a TFSA makes sense.
Pierre: Exactly. Another case would be a person in his early fifties whose employer offers a defined benefit pension plan. If that person wishes to save more money for retirement, we would recommend the TFSA as well. Why? Simply because when you add pension income, Old Age Security (which is the Canadian pension plan), you attain a level of income that is taxed at a high rate, just like a salary. However, by using a TFSA, you can generate some extra non-taxable income. In turn, this provides you with greater lifestyle flexibility during your retirement.
Sébastien: In this example, the person is in his early fifties and faces a short 10 to 15-year interval before retirement. For those in their thirties or forties with a defined benefit pension plan in place, would you still recommend a TFSA?
Pierre: TFSAs are better suited to people in their fifties who have a shorter time horizon. The decision to choose a TFSA would be based on their pension and their annuity.
Pierre: That’s what we look at. As you know, contributing to an RRSP reduces taxable income. However, another important factor to consider regarding RRSPs is that they enhance your eligibility to social programs and credits offered by various governments. Let’s take as an example a single parent with two young children and an annual income of $50,000. By contributing to an RRSP, this person would probably increase her income as a result of family allowance.
Ashleay: Just to be sure I understand correctly, if you contribute a little more to your RRSP, you get more in the way of credits from social programs. Is that correct?
Pierre: Yes, that’s the idea. If you’re already eligible or just on the verge of eligibility –
Pierre: By contributing more to your RRSP, you reduce your taxable income, which makes you eligible for credits or increases the credits you already receive.
Ashleay: I see. Great. Thank you.
Sébastien: If you want to buy your first home, what’s the better choice: RRSPs or TFSAs?
Pierre: RRSPs already include a program for first-time home buyers. Starting this year, you can use your TFSA for that purpose as well. We recommend both because you can have both, which is good. But if you want to buy a cottage or sell your house to buy a bigger one, then, of course, you have to use your TFSA to accumulate the funds you need.
Sébastien: Giving money to your spouse is often cited as an advantageous fiscal strategy. But a donation is a donation, right?
Pierre: Yes. Once you’ve made a gift of money to your spouse, he or she gets to decide what to do with the funds – not you.
Ashleay: Sébastien just mentioned strategies. What are my options or strategies regarding the tax refund? Are we richer than we think?
Pierre: Your best strategy is to improve your financial situation as a whole. You can work both on your debts and assets. First, given rising interest rates, you should pay off your high-interest debts, such as credit cards and lines of credit. Next, focus on assets by increasing your investments and maximizing your RRSP or, at least, contributing to it. Use your tax refund to contribute to your RRSP next year, thereby increasing next year’s return and the value of your RRSP. You can also use your refund to maximize your education saving plans (RESP) contribution. If you contribute to an RESP, you get a 20% grant from the federal government. Depending on which province you live in, you may also get a provincial grant. A benefit of RESPs is that withdrawals are taxed in the hands of the student. Since many students have little or no other income, they can usually withdraw the money tax-free. Another option for increasing investment is to maximize your TFSA. It’s a good way to shelter your money from taxes. TFSA income is not taxed, and you can spend it however you like. To recap: reduce high-interest debts and increase assets.
Sébastien: RESP is a tool that families should use extensively, right?
Pierre: Yes, mainly because of the grants, which can be as much as 20% depending on where you live. RESPs provide tax-sheltered growth and enable income-splitting. As I mentioned earlier, it is students who are taxed on the income the account generates.
Sébastien: On this podcast, we’ve been discussing inflation for the past two years. The fact that, in 2023, you can contribute $500 more to your TFSA is related to inflation, right?
Pierre: That’s right. The TFSA was created as a retirement tool. Since we need more and more money for retirement in response to inflation, salaries are rising, but so is the contribution limit for TFSAs.
Ashleay: With rising mortgage rates, should we pay off our mortgage or increase investment? If our only debt is the mortgage, which choice do you recommend?
Pierre: We recommend investment. Mortgage rates are rising, but your house is increasing in value. You can manage this situation on a monthly basis. It may be difficult for a while, but your assets are growing. By making investments, you reap tax benefits. In other words, money you can use whenever needed. Increasing investment means more liquidity, which is always better.
Ashleay: Absolutely. Great. It’s been a pleasure, Pierre and Sébastien. We’ve learned a lot. Thank you to our listeners for being here. If you want to know more about this subject, visit our advice zone on ia.ca, in the finance section. It’s filled with articles that can help you on a daily basis. So we’ll see you next week. Love this podcast? Want to know more about economic news? Follow our “In Your Interest” podcast available on all platforms. Visit the economic news page on ia.ca or follow us on social media.