In the last article, we have looked individually at each of the six key factors for determining your optimum RRSP/TFSA contribution. In this article, we will put all these pieces together to create your optimal RRSP/TFSA strategy to determine the optimal contributions for you to make this year and in future years.
Putting all the 6 factors into a strategy in the optimal way is a combination of art and science. You need to look at each of the six factors and decide what makes sense. It would be nice if all six factors pointed to the same number, but that rarely happens.
The Steps to Determine your Optimal Strategy:
Step 1: Start with the annual contribution necessary to achieve your retirement goal.
Building up the nest egg you need to have the retirement you want is the real purpose of this long term investing, so you should start here.
Step 2: Adjust based on your tax bracket
A bit of planning can get you the maximum possible tax refund percentage. Hopefully, you can contribute the amount needed for your goal all within your current marginal tax bracket. If not, then we will have to consider what to do with the excess. We could contribute it as well, leave it for the following year, or contribute it to a different plan, such as your spouse’s RRSP or to a TFSA.
Step 3: RRSP or TFSA?
The deciding factors are your marginal tax bracket today when you contribute compared to your expected marginal tax bracket based after you retire and withdraw, including the effect of the clawback of government programs. The other issue is how you use your tax refund.
To determine whether RRSP or TFSA is better for you, you need to know what your expected income will be after you retire based on your retirement goal. In general, if your marginal tax bracket is higher today, then RRSP is better and if it will be higher after your retire (perhaps because of the clawbacks), then TFSA is better. If they will be the same, then TFSA is probably better, depending on how effectively you use your tax refund.
Step 4: Adjust based on your lifetime RRSP and TFSA contribution room
There are two possible issues here – running out of room and never using your room.
If you will run out of room, then how will you invest after you have hit the maximum?
If you will never run out of room, there are sometimes reasons to contribute more than is required for your retirement goal. The retirement goal is an estimate, so being ahead of your goal provides a buffer for future negative events. If you have cash available, you can take advantage of the RRSP and TFSA tax benefits.
Investing in an RRSP provides tax savings if you can get a larger tax refund today than the tax you will pay when you withdraw. Both RRSP and TFSA allow your investments to grow tax free.
Step 5: Adjust based on the tax refund you want
If you have a specific purpose for your tax refund, such as contributing to the RESP for your children or paying off a debt, then you may want to adjust your RRSP contribution in specific years. This may also affect your decision on spitting your contribution between RRSP and TFSA.
Step 6: Adjust based on cash or borrowed funds available
Note that the cash available includes your cash on hand, your expected tax refund, and the amount you can afford to borrow for your contributions. If you do not have the cash available to contribute the amount you want, there are a wide variety of strategies, such as the “RRSP top-up” and “2-year RRSP loan strategy” (both discussed in the last article) that can help you.
Step 7: Decide on your optimal RRSP/TFSA strategy
Once you have worked through the first 6 steps and weighed all the factors, you should be able to determine your optimal strategy. It should work for this year, and provide a plan for contributing in future years right through until you retire.
You should also consider how much of any RRSP contribution to contribute to a spousal RRSP. In general, it is a good idea to try to plan for you and your spouse to have similar taxable incomes after you retire. Some types of retirement income can be split, but not all types and the rules may change in the future. A spousal RRSP is a good tool for saving tax in the future through income splitting.
Your final decision should determine the specific RRSP, spousal RRSP, and/or TFSA contribution for both you and your spouse.
Stay tuned because the next article will feature a case study to make these concepts more concrete.
What is your optimal RRSP/TFSA contribution strategy?
About the Author: Ed Rempel is a Certified Financial Planner (CFP) and Certified Management Accountant (CMA) who built his practice by providing his clients solid, comprehensive financial plans and personal coaching. If you would like to contact Ed, you can leave a comment in this post, or visit his website EdRempel.com. You can read his other articles here.