Ed Rempel (CFP/CMA) is back!  This article will pit the new Tax Free Savings Account (TFSA) against the old school RRSP with the main focus being the potential GIS/OAS clawback during retirement.

“The future ain’t what it used to be.” – Yogi Berra

Tax Free Savings Accounts (TFSA’s) were just announced in the recent federal budget. At first, it seemed they would be not nearly as useful as RRSP’s since there would be no tax refunds for contributing. However, we are starting to analyze TFSA’s and it seems they beat RRSP’s most of the time. Credit Stephen Harper for implementing what may eventually become the most effective retirement savings vehicle for many (perhaps most?) Canadians, as well as a very useful tax saving tool.

To understand why TFSA’s will beat RRSP’s as a retirement savings vehicle for many Canadians, we first need to understand income tax on seniors.

TFSA’s appear to be almost exactly the same as RRSP’s, except without the tax refund on contributing and tax on withdrawals. Therefore, to determine whether TFSA’s or RRSP’s are better for you depends mainly on your tax bracket when contributing (during your career) vs. your tax bracket when withdrawing in retirement.

A common part of retirement planning and one of the main benefits of RRSP’s includes the assumption that most Canadians will be at lower income tax rates after they retire than they are during their working career. This may sound logical, but it is often not true. In fact, on average, when you include clawbacks on several programs for seniors, income tax rates on seniors are almost 50% higher than on adults under 65!

Our Canadian outlook of always looking after the have-nots has led to quite a few benefits for seniors that are clawed back based on income. The idea is that those with a lot of income do not need the tax relief. The end effect, however, is very high rates of income tax on seniors.

The 3 main Clawbacks that affect seniors are clawbacks on the Guaranteed Income Supplement (GIS), the age credit and on Old Age Security (OAS). GIS is a supplement of up to $7,608 of tax-free income paid to seniors with an income under $15,240. Essentially, for every $2 of taxable income, the GIS is reduced by $1. The age credit is a tax credit of $5,177 that is reduced by 15% for any dollar of income above $30,935. Maximum OAS is a taxable income of $6,028 that is also reduced by 15% for incomes above $63,510. (The OAS clawback is not quite as bad, since we at least get credit for the income tax we would have paid on the OAS.)

There are also clawbacks that apply to adults under 65, such as employment insurance and the child tax benefit, but none of them apply to everyone at any given tax bracket.

When you add the clawbacks that affect seniors, here are the approximate marginal tax brackets in Ontario for adults under 65 vs. seniors. The marginal tax rates apply to everyone, while the tax rates with clawbacks apply specifically to anyone 65 and over.

(Click for larger image)

Here is an updated table for 2010 that fixes a few errors.

Note that the average tax rate on seniors up to $121,000 on income (the start of the top tax bracket) is 45%, compared to 32% for adults under 65. This is a difference of 13% of income, or a total of 43% higher tax to pay for seniors!

Note also that seniors making under $15,000 or over $37,000 are almost all taxed higher than the top tax bracket of 46% for non-seniors!

The lowest tax rates for adults under 65 are on eligible dividends. In fact, the tax rates are negative at a few tax rates, but this is now being eliminated by 2010. The latest budget has increased income tax rates on dividends, which appears to increase them to no lower than 0% at any income level. So the marginal tax rates on most dividend income will be a bit higher than on this chart by 2010.

The lowest tax rates for seniors, however, are on capital gains. This is because the clawbacks are on taxable income – which is only 50% of capital gains but is 145% of dividends. For example, for seniors with no other income, the 50% GIS clawback is only a 25% clawback on capital gains income, but is a 73% clawback on dividend income.

Is there logic to these tax rates? Why should dividends have the lowest tax rate for adults under 65 who are building retirement assets, while capital gains have the lowest tax rate for seniors trying to get an income from their investments? It sounds backwards, but there is some logic when you understand the way CRA structures tax on investment income.

Many Canadians, if they have saved a good nest egg or have a decent pension, may be retiring on incomes of 50-70% of their working incomes. For example, an average Canadian may earn $50-60,000/year during their career, which would put them into a marginal tax rate of 31%. When they retire on say $30-40,000, they would be at a marginal tax bracket of 37% – which is higher than during their working career.

Note that many seniors will be at lower tax brackets in retirement, however. This is because most Canadians, if they have only modest savings for retirement, will likely be retiring with incomes of only $15-30,000/year, which would put them in the lower 22% tax bracket.

All of these tax brackets are adjusted for inflation each year. This means that the income amounts for each bracket will be close to double the figures in the above chart in 25 years.

What does all this mean for the usefulness of Tax Free Savings Accounts (TFSA’s)? That will be the subject of our next article.

photo credit: Marcin Wichary

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Wait now, isn’t that chart a little misleading? Say for instance you make 20000 in retirement from interest income your GIS clawback will be 7608, or 38% of your income, and also you will pay around 2250 in income tax, 11.25%, making the total percent of your income ‘lost’ to tax at just shy of 50%, not 22% like the chart describes. Am I maybe reading something incorrectly?

This argument I always find a little distasteful however. The same thing could be said about anyone making 40K a year and supporting a family. They are giving up social assistance, a pile of child tax benefits, assisted housing, and all sorts of other social benefits . . . so why bother working?

[P.S. it’s because relying on society to pay your way is no way to live at all, just in case there is any confusion here].

Interesting way to look at it.

I’m of the opinion that the effects of the OAS clawback are greatly exaggerated – you need to have an individual income of $63k to START the clawback and I think you need to make about $100k for the complete OAS clawback. Considering you can share pension income if you are over 65 then most couples would need an income of more than $126k (in today’s dollars) to start getting clawed back and $200k for the complete OAS clawback. I can tell you that’s not going to be my situation.

I think if you are going to get a good defined pension in retirement, then the OAS clawback might be a consideration and the TFSA is probably a better choice than the RRSP since you might not have much rrsp room left anyways.

I would argue that the majority of Canadians who DON’T have a good DB plan are better off maxing their rrsp first. The exception might be someone who is literally saving “too much” for their retirement ie someone who just wants to keep working.

GIS is a different kettle of fish altogether – it’s not an issue about whether rrsp is better than tfsa since for someone who is low income, contributing to an RRSP is a poor choice regardless of whether they have a tfsa to use or not. For a low income saver, the tfsa will be a good tool since it will eliminate the tax drag of a non-registered account which is currently their best option.

Mike

I’ve always felt that if I end up getting some of these social benefits clawed back then I’m likely already doing alright in other areas. If my biggest concern upon retirement is that I’m earning too much income, then I’ll consider myself in pretty good shape.

I do like the TFSA though. Simple and effective especially for lower income earners as FP states above.

Peter

Great comment Mike. You made many of the points I was planning to make (but probably more eloquently ;) ).

I also think Traciatim’s comparison to giving up social assistance during working years is valid here. Do I feel bad that various forms of government assistance are not available to senior couples with > $120k / yr income? Not really. But this is why it’s important to plan ahead and project your income in retirement. If my husband and I plan to have $100k / yr in retirement and end up with $130k with some benefits clawed back, I surely won’t complain.

I find people seem to forget something when comparing RRSP vs TFSA and that is current cash. By “current cash” I mean cash available to me now (or in the very short term). If I put $5000 into my RRSP I get about 1500 back on my tax return. I can then take that $1500 and buy my groceries or roll into the next years RRSP or spend it on “current expenses”. Sometimes, even though it will cost me future dollars, I ~need~ current cash (like I currently need $55k for a downpayment on a house). In those cases maybe a RRSP is the best way because it enables you to save more now… continuing the example from above.. to “invest” $5000 into my RRSP will cost me $5000 – $1500 (refund), or about $3500 of current cash. If I only want to give up $3500 of current cash, I can only put $3500 (no refund) into my TFSA…

What do you guys think about this comparison?

-MikeG

Telly – I agree – planning is the key and if I end up paying a bit of oas clawback then I won’t be crying for very long… (unless they are tears of joy).

MikeG – I think that is the correct way to look at it – pretax money in the rrsp, post-tax money in the tfsa.

One of the changes in my situation that the TFSA might cause is for me to have a proper emergency fund. I’ve posted numerous times about how I think having a line of credit is a better emergency fund than a pile of interest-generating cash which is getting taxed at your marginal rate. Once the TFSA goes through then I think I will change my strategy and start saving in a TFSA which will be an emergency fund/car buying/vacation/big tv fund.

Mike

MikeG, note that spending the RRSP tax refund significantly reduces it’s long term benefits. If the RRSP refund is spent every year, I believe the TFSA would win every time.

I think it depends if you expect OAS and GIS to be around when you retire.

But I still have a problem equating clawbacks with tax. Money you didn’t earn is not the same as money you had to pay out.

I have to believe there will be some tweaking done over the years to ensure that those with large TFSAs will not qualify for the GIS. Any form of social assistance should be for the truly needy, and IMHO shouldn’t be applied to a calculation for those who would have substantial amounts of money in either RRSPs or TFSAs.

As FP noted above I think the TFSA will make an excellent emergency fund. Also, once your contribution room has grown it will be a great way to tax shelter income made from lump sums like inheritances, home downsizing etc.

@FrugalTrader

Can you please explain how/why spending the RRSP tax refund reduces the long term benefits? Not to say you’re wrong, just to say that I dont get it..

-MikeG

MikeG, I don’t have the numbers in front of me, but if you visit Preet’s site or read his book, you’ll get all the calculations there.

To explain it in words:

RRSP:
tax return
-compounds tax free
pay taxes on withdrawal

TFSA:
no tax return
-compounds tax free
no tax on withdrawal

So if you take away the tax return advantage (by spending) of the RRSP, the TFSA will have the bigger advantage as no taxes are paid on withdrawals.

To basically summarize Preet’s findings, RRSP’s are one of the best ways to save for retirement PROVIDING that all of the RRSP tax return is used efficiently (reinvested, debt etc).

FT, if someone is maxing out their RRSP by making regular contributions, they can feel free to spend their tax refund (or use the TFSA) since that money can not be re-contributed anyway.

Mike, I was thinking we’d use the TFSA for the same reasons you gave (although we won’t need it for a big tv as we’ll be using the tax refund to purchase that next week ;) ).

Telly, I believe the studies showed that the refunds should be used “efficiently”. Meaning either re-contributed to the RRSP or used to pay down debt. If the refunds were “spent”, then investing in a non-registered portfolio came close.

I think you can use the refunds for any kind of savings (TFSA anyone?) and the rrsp will come out ahead.

FT is right tho – if the refund just disappears then there is no advantage to the rrsp.

Telly – I noticed the Habs are in first place in the east, which I didn’t realize. They will look good on that new tv.

Oddly enough I haven’t looked at the standings for a while.. :) (Leaf fan)

If an RRSP refund is “spent” but you are in a lower marginal tax bracket in retirement than you are when you make the contribution, you are still ahead by investing in a registered account, even if you blow the refund on a big tv.

Mike – the Habs beat Jersey last night to move into 1st. The basement is about 2 weeks away from completion so perfect timing for playoff hockey on a 50″ HD TV. Yeah, it’s pretty splurgy but sooo worth it. :)

FP, the majority of Canadians can barely think of saving 2K per year into a RRSP. Therefore, they will not even get closed to get to the TFSA.

However, for those who are financially aware, they will probably have a good pension plan, RRSP and more money aside. Those are the one who should be concerned about the OAS clawback. 63K as a retirement income is not that much any more… for some people ;-)

I am going with the assumption that by retirement time, the funds in my TFSA are going to impact my ability to receive GIS/OAS benefits.

Still, I will be maxing out my TFSA before I put funds in to RRSPs. The TFSA allows a lot more flexibility than an RRSP does and at my tax bracket, I will likely be withdrawing my RRSP at the same rate that I am putting it in. This is also based on the expectation that my income level will increase (above inflation) as I move further in my career, pushing me to a higher bracket and making RRSPs the more advantageous investment.

If it does turn out that GIS/OAS are not clawed back on TFSA money (or only partially clawed back), then I will end up much farther ahead than if I used an RRSP first.

Sarlock – Don’t be so sure that you will be withdrawing your RRSP at the same tax rate you are contributing. Even if you are in the lowest income bracket, unless you have income from another source (eg: defined benefit pension plan) your tax rate on withdrawal will likely be lower than your MTR on contribution. If you contribute to your TFSA, you’d have to be making less than approximately $17,000/yr in order to pay less than MTR on that money.

The TFSA is certainly a more flexible savings vehicle (in its currently proposed form), but the RRSP is still superior as a retirement savings vehicle in almost every case. Not only will you come out ahead after tax in the RRSP scenario, but the increased PITA factor of early withdrawals from an RRSP vs. from a TFSA will reduce the temptation of dipping into that money before retirement.

Hi Traciatim,

These tax rates are marginal tax rates – not average tax rates. They are the tax rate on the next dollar of income.

Your example of 50% of income being paid in tax by someone with an income of $20,000 is right, but if they make $1 more, they will only pay 22% of that dollar on tax.

You are right that not qualifying for GIS is not really relevant for someone making $40,000. But GIS is very relevant for someone making $15,000 who will lose $.72 of the next $1 of income.

Ed

Hi Cheap Canuck,

We would be surprised to if withdrawals from a TFSA would ever affect GIS or OAS clawbacks. TFSA’s were designed to be a certain amount of investments that we can invest with no tax on the profits. Therefore, they are more like a tax-free non-registered investment than like an RRSP without tax consequences.

If TFSA withdrawals would ever affect clawbacks, then the principal related to any withdrawals from non-registered investments would logically also have to affect the clawbacks.

Ed

Hi again Cheap Canuck,

I don’t understand your post 18. If you are in the lowest tax bracket now of 22% (lowest other than 0%), there are no lower tax rates for seniors.

If your income now is under $37,000, then you are probably in a 22% marginal tax bracket. After you retire, you may well be in the $15-31,000 tax bracket and still be at 22%. However all other tax brackets for seniors, whether lower than $15,000 or higher than $31,000 are all higher than 22%.

We agree with you about the flexibility of TFSA’s may make them less effective for retirement savings for many people, if they would be more likely to raid their retirement fund for current spending if it is in a TFSA.

Ed

Ed – I came up with my numbers by plugging some arbitrary info into the income tax estimator at:

http://www.walterharder.ca/T1.html

I simulated a couple who had managed to save $125,000 each in their RRSPs while contributing in their earning years at a 20.35% MTR (BC MTR for 2008 tax year for someone earning say $30000 a year). Assuming a safe 4% rate of withdrawal, their yearly pension from RRSP is $5000.

For Tax Year 2008 in British Columbia I entered the following numbers:

Age 65-69, married.
OAS field fills automatically – $6070 each
CPP field – $6000 each
Eligible pension (RRSP Withdrawal) – $5000 each
________________________________________________
Total income – $17070 each
Total tax bill – $176.82 each

Even if you attribute the entire tax due to the RRSP withdrawal, the tax rate is only 3.54%

I’ll admit I’m far from an authority on the subject, and I may be applying faulty logic (or the tax estimator may be providing incorrect results), but it seems the 20.35% Tax deduction on contribution vs. 3.54% tax on withdrawal (RRSP Scenario) would beat the guaranteed 20.35% deduction you’d face by contributing to the TFSA.

If this is incorrect please let me know as I am currently in that 20.35% tax bracket and I’m using these calculations to try to figure out the best strategy for allocating my savings over the coming years :)

Thanks for the link FT! Have a good weekend. :)

Preet

CheapCanuck, what you’re missing in the calculation is that the GIS clawback starts at dollar one, So the $5000 withdrawal from the RRSP will incur a $2500 clawback from the GIS and the 3.54%. Calling the loss of your GIS a tax is kind of low, as you can see above I count this as the same as counting your loss of social assistance as a tax for working.

Of course, this doesn’t help people that are currently 65+ and want to adjust their incomes from money in their RRSPs, but people who are younger can start planning now to have income from a TFSA that won’t effect these benefits until the rules get changed.

Traciatim – I agree that calculating the GIS clawback as a “tax” is definitely a grey area. Below is a new set of calcs that will take the GIS clawback out of the picture, but still produces an income tax rate on RRSP withdrawals of below MTR:

Take the same couple, and assume they worked their whole lives, so they each have CPP near the max, but the same $125,000 each in their RRSPs.

$6,070 OAS each
$10,000 CPP each ($20,000 income between them puts them out of reach of GIS before any other pension income is factored in.

total tax on this income is $326.82 each

Add $5,000 each in RRSP pension income
total tax bill is now $990.82 each

Thus the tax attributable to the $5,000 from the RRSP withdrawal = $664 or 13.28%

Still well below the 20.35% MTR on contribution, with GIS clawback now out of the picture. Age amount is not affected, and they are obviously nowhere near the income needed to trigger OAS clawback.

Adding in some dividend income could drop this rate even further (in 2008 in BC).

Scale the CPP back to $6000/yr each
OAS still at $6070 each
RRSP withdrawal $5000 each
$5000/yr each in dividends

Total tax bill on this income is now $0!
You can’t attribute more than the total tax bill to the RRSP withdrawal, so the effective tax rate on withdrawal is 0%

The scaling back of the dividend tax credit over the next few years will reduce this benefit in the future, but here in BC at least the net tax on dividends at this income level will still remain in the negative.

Hi Traciatim,

I think it is entirely fair to consider the GIS clawback to be a tax. Your comparison with social assistance (welfare) is not the same at all.

GIS is a universal program that applies to everyone over 65 in that tax bracket. It is part of the OAS program that is clawed back on your tax return. GIS would also be clawed back on the tax return, except that it is not taxable.

Welfare, on the other hand, requires that you apply, dispose of most of your assets and jump through hoops. You can’t get it just because you earned no income for a year.

Ed

Hi Cheap Canuck,

Your tax rate percentages are not an apples to apples comparison because you are comparing marginal tax rates now while you work with average tax rates after retirement.

The 20.35% rate is approximately the lowest marginal tax rate in BC for those under 65, while the 3.54% rate is the average tax rate.

There is a lot of common betweent these 2. Marginal tax rates are the tax on the next dollar of income, while average tax is just your total tax divided by your taxable income. The average tax rate is the weighted average of all the marginal tax rates.

For tax planning, marginal tax rates are far more important because that is how much more tax you will pay on a bit more income or how much less tax you will pay if you add a tax deduction, such as an RRSP contribution.

You are getting low tax amounts because the age credit and pension credit kick in. My tax table above is not completely accurate in that the amount a senior can make with no tax (other than the GIS clawback) is $16-17,000, once you include the age credit and the the pension credit.

However, the GIS clawback would apply in all your examples. It applies to income up to $15,240, but OAS is not included in that calculation. So, if you get the maximum oAS, then the clawback applies to income up to $21,192.

For example, in your last example, the $6,000 CPP and $5,000 RRSP total only $11,000, so the GIS clawback still applies. If you then make $1,000 of dividend income, you would lose $720 of GIS, so you are in a 72% marginal tax bracket for dividends. They are clawed back at 50% on the dividend after grossing it up by 45%.

Ed

[…] Dollar Journey has a guest post about TFSA and RRSPs. I’m trying to learn a little more about how personal finance is different in Canada, so that […]

Sorry Ed. I was under the impression that a couple could only earn about $20,000 between them and still qualify for GIS (read that somewhere in the Q&A section of Gordon Pape’s website). Since the couple in my last example made $22,000 between them before OAS or RRSP withdrawals I thought that the RRSP withdrawal would have no bearing on a GIS clawback calculation.

Hi Cheap Canuck,

Actually, you are right. I was looking at the individual clawback threshold of $15,240, but the threshold for a couple is only $20,112. I verified your figures as well and yes, the couple in your post 27 would pay less than $100 tax.

They have just enough taxable income from the CPP, OAS & RRSP to be tax free. This is $17,000, which is the total of the personal, age & pension credits. They are also in the window with income between $21-31,000 where the marginal tax rate is low and the dividend marginal tax rate is still negative.

Your point is well taken, but this would only apply to people in that narrow band of income – which is quite a few people.

Incidentally, if they were doing the SM and had some interest deductions, they would still qualify for the GIS. This is especially true if they had capital gains instead of dividends (because of the gross-up).

Ed

Yes, it definitely requires some longterm planning to try and position yourself to be able to draw the money out at a much lower rate than you were refunded upon contribution. Why I like the RRSP is that it gives you the flexibility to accomplish this, where the TFSA doesn’t because you’ve already paid the MTR up front.

As you point out this income window can be pretty narrow for seniors when potential clawbacks are taken into account, and hitting that window could be tricky.

However, the situation is much simpler for those in a position to retire early, and their RRSP withdrawals will be their only income source until OAS and CPP kick in later. They can withdraw ~$10,000 each without paying any tax at all.

It is definitely a mind-bender trying to come up with the most tax-advantageous strategy. Ideally, I guess it would be to contribute to the RRSP, retire early, and somehow melt down the RRSP into a TFSA (at a withdrawal rate lower than MTR) before age 65, so as to face no clawbacks. How to accomplish this scenario I have no idea. Anyone else out there got the recipe? :)

I have been reading “The Pension Puzzle” by Bruce Cohen and Brian Fitzgerald which has really helped me to understand many of the components that we are talking about in this post and comments. Of course it does not include the TFSA but it was a good grounding for me in this topic. Looking forward to the next edition with the TFSA which I will buy, instead of borrow from the library.

I’m not sure about some of the comments. I understand that you may feel you are doing well financially and losing out on funds through clawbacks is okay because you feel you are doing well. How very Canadian of you. For me, if I can avoid any clawbacks by rearranging my accounts in a different fashion and absolutely legally, while still maintaining the same investments, why wouldn’t I do so. I have many years of compounding to come before I retire.

Hi Quentin,

Right on. There is no practical difference between a tax and a clawback.

It is exactly the same if our client pays tax or has a benefit clawed back. In both cases, they have lost money. If we can arrange their finances differently so they can either reduce tax or reduce a clawback, that’s what we will do.

Ed

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I think it’s a bit misleading to say that the “tax” is higher for seniors given the clawback. What the article fails to mention is that seniors are receiving a benefit that non-seniors do not receive. So are we as younger Canadians being short changed? No we’re not. The trust is that as income rises through retirement, these befits should be rolled back to ensure those who do not need them do not receive them. I agree it does not always work as planned but the article is still mis-leading.

Hi Tax,

You are technically right. We just look at what works best for our clients, though. If they would use a TFSA, then they may get more government benefits than if they used an RRSP, so if that is true, then the TFSA would be a better choice for them.

Ed

I am 62 and my husband is 65. Can i use his age credit to reduce my tax bill??

Gemini asked

[/Gemini] | April 10th, 2008 at 3:59 pm
I am 62 and my husband is 65. Can i use his age credit to reduce my tax bill??
[quote]

please see

http://www.fin.gc.ca/pensioncalc/factsheet_e.html

Ed,

I still haven’t quite figured out how the GIS clawback works and how punitive it is.

For example, if I collect an OAS of $5,000 and CPP of $7,000 and no other income, will I receive a GIS of $7,608 – 50% x ($5,000 + $7,000)? Is there a good online GIS clawback calculator or discussion that talks about how to minimize this effect?

I’m thinking if it is possible, better to plan for it now rather than wait until it is retirement time.

Thanks.

I see some real problems with the marginal percentage rates in the table and I think it needs some reworking. There is no doubt that phaseouts and clawbacks result in some bizarre marginal rate calculations, plus they introduce philosophical questions regarding whether we’re talking taxes or welfare, as hashed out above. Even if the table were right, it’s still a simplification because of other effects not considered, such as GST credit eligibility or an impact on other programs like medicare and its ancillaries. In BC, for example, where there are monthly medicare premiums and a pharmacare program, and penalties (whether you consider them taxes or subsidies to those with lower incomes) that become onerous as soon as your income is $20k+, the calculations are complex and the results can be brutal.

For an example of where the table is wrong, consider the age credit phaseout for a person with $40k in pension income (and $6k in OAS). The table says the marginal rate on pension or interest is 46%. Plug those numbers into the Harder calculator and you will find that the marginal rate in Ontario is 34.3%. That’s higher than the normal 31% for that sort of income in Ontario but not ridiculously higher.

Hi Cannon,

You are basically right. The GIS maximum for a single person is $7,608 and is reduced by 50% of taxable income. OAS income is excluded for any GIS calculation, though.

To calculate it, check out Service Canada’s table:

http://www.hrsdc.gc.ca/en/isp/oas/tabrates/tabmain.shtml

Ed

Hi Sam,

Your comments are well said. I simplified this table. In actual fact, there are about twice as many small marginal tax rate brackets, but I tried to put just the major brackets to keep it more simple. The figures should be very close, though.

There are all kinds of factors that may or may not affect different people. I have included only the government factors that apply to everyone. If there are any other factors that you think should be included, I would gladly publish expanded tables.

My main point is that surprisingly many seniors will be in higher tax brackets than during their careers. I think this trend will continue in Canada where we constantly try to support lower income people in every program.

Ed

I was wondering which plan in which to place $5,000 each year. Here is the results of an Excel comparison. The RRSP after tax column represents what is left if the money is taken out at the age 66 MTR. This analysis is challenging my long held belief of RRSP-good, Savingings Accoun-bad.

The bright ray is that the new TFSP is not dependant on the post retirement MTR! (maybe it’s time for my non-employed wife to start transferring her RRSP to TFSP, $5,000 per year!)

Assumptions
MTR 0.43
Interest 0.035
MTR at 66 0.46

Year Invest RRSP RRSP TFSP Bank
after tax Account
0 5,000 7,150 3,861 5,000 5,000
1 5,000 14,550 7,857 10,175 10,100
2 5,000 22,210 11,993 15,531 15,301
3 5,000 30,137 16,274 21,075 20,606
4 5,000 38,342 20,704 26,812 26,018
5 5,000 46,834 25,290 32,751 31,537
6 5,000 55,623 30,036 38,897 37,166
7 5,000 64,720 34,949 45,258 42,907
8 5,000 74,135 40,033 51,842 48,763
9 5,000 83,879 45,295 58,657 54,736
10 5,000 93,965 50,741 65,710 60,828
11 97,254 52,517 68,010 62,042
55,000

ConservativeInvestor,

It is a commonly held belief that if you withdraw funds from your RRSP at a higher MTR than the funds went in, then it is not a good plan.

If you are going to withdraw money from your RRSP at an MTR, not average, of 46% then that means you have a lot of other income. In Ontario you’d be at about $65,000 of income to get around that MTR but your average tax rate would still be under 25%. Getting $65,000 of income in today’s dollars before you even tap into your RRSPs/RRIFs would be a nice problem to have for a lot of us!

Hi Conservative,

I don’t understand your point. Why did you show the TFSA at $3,861 in year 1, instead of just at $5,000?

The MTR when you withdraw vs. when you contribute are both completely relevant in comparing the TFSA to RRSP.

Ed

Hi Cannon,

If you are over 65 when you withdraw, you are over the 46% MTR at $37,000 or over and at $15,000 or less. Both are not very high incomes.

You are right though that there are other factors in determining whether RRSP’s are a good plan. There is also the the advantage of tax-free compounding. TFSA’s have that too, but only to $5,000/year.

Ed

The columns were not maintained when I pasted excel into the box so it’s hard to get the meaning. On reflection, I had not included the original RRSP tax deduction in next year’s RRSP contribution so the RRSP total after 10 years was understated. After the corection, the RRSP beat the bank account, but lagged a bit behind the TFSA. The 46% MTR rate for after retirement came from the table shown near the top of the page for the 37-63 income range. I am assuming that the RRSP will be taken out as needed at the MTR.

Ed,

I understand your point and I’m slowly coming around to look at MTR that includes clawbacks from handouts I may never get.

Perhaps you could offer some insight as to why the age credit seems to be lost in the discussions around CPP, OAS and GIS. Even CRA’s retirement calculator doesn’t mention the age credit.

Google can come up with all kinds of pages mentioning CPP, OAS and GIS but age credit gets short shrift.

Is there some caveats that aren’t obvious (like it is not expected to be there as baby boomers start drawing from the tax coffers in record numbers)?

Hi Conservative,

The bottom line with your example is that if your tax bracket is 43% while you work but 46% after you retire, then the TFSA is better for you than RRSP’s.

Ed

Hi Cannon,

Good point. I don’t know why there are not more articles about the various clawbacks, especially the age credit. I have not looked at CRA’s calculator.

The “caveat” here is that clawbacks are starting to proliferate. I only included the main tax clawbacks that apply to everyone above, but there are a variety of other benefits for specific types of people or provincial clawbacks that make their tax rates even higher.

For example, Ontario just announced a property tax credit for seniors of $250 that is clawed back at 2%.

Many seniors in retirement homes have their rent subsidized based on income. I have met people in 120+% tax brackets because their rent subsidy is reduced by 50% of any additional income, plus the GIS clawback and of course, the 22% income tax. For them, getting a GIC with a higher rate is bad for them.

This seems to be part of the Canadian Psyche. We like to provide all kinds of benefits for lower income people, but then don’t want it to go to people with other income – so we create a clawback.

As the baby boomers retire, my guess is that clawbacks will proliferate. The total of clawbacks plus income tax for many of us baby boomers may become shockingly high.

Ed