Blinded by the Refund : Why TFSAs may beat RRSPs as better retirement savings vehicle for some Canadians by Jamie Golombek

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4 Chart 4 Dick and Jane - Withdrawals Future value of savings - age 45 to 65 Dick (RRSP) Jane (TFSA) \$173,596 \$119,521 Annual withdrawals - age 65 13,930 9,591 to 85 Tax on withdrawals (4,339) n/a Annual after-tax cashflow from retirement savings \$9,591 \$9,591 Note: Assumes beginning of year contributions, 5% growth rate, equal end of year annual withdrawals, zero balance left at end of 20 years and 31.15% marginal tax rate for Dick. Of course the big assumption equating the annual retirement cashflows is that both Dick and Jane remain in the same tax bracket when they access their funds upon retirement as they were in when the initial contributions were made to the RRSP or TFSA. Let s explore the accuracy of this assumption and its applicability to Canadians in more detail. Tax rates working vs. retirement As the example of Dick and Jane illustrated, whether one invests in an RRSP or a TFSA is nearly irrelevant if you re in the same tax bracket when you withdraw the funds as you were in when you made your contribution. Many Canadians, however, believe that they may be in a lower bracket upon retirement making the argument for contributing to RRSPs over TFSAs. Let s take a closer look at this by exploring the three possible scenarios side by side: the constant tax rate assumption, the high rate to low rate assumption that favours the RRSP over the TFSA and the low rate to high rate assumption that reaches the opposite conclusion. (Chart 5) The first column, reproduced from Chart 1 above, shows the constant tax rate assumption, which shows that with constant tax rates, you should generally be indifferent between investing in a TFSA or an RRSP. The second column shows that RRSPs will produce a better result when the tax rate upon withdrawal is expected to be lower than the tax rate upon original contribution. Conversely, the third column demonstrates that TFSAs will provide more after-tax cash if your tax rate will be higher upon ultimate withdrawal than it was when you contributed. Chart 5 Same Tax Rate High/Low Low/High TFSA RRSP TFSA RRSP TFSA RRSP Pre-tax income \$5,000 \$5,000 \$5,000 \$5,000 \$5,000 \$5,000 Tax rate - contribution 40% 40% 20% Tax (2,000) - (2,000) - (1,000) - Net contribution 3,000 5,000 3,000 5,000 4,000 5,000 Growth at 5% / 20 years 7,960 13,266 7,960 13,266 10,613 13,266 Tax rate - withdrawal 40% 20% 40% Tax - (5,306) - (2,653) - (5,306) Net cash \$7,960 \$7,960 \$7,960 \$10,613 \$10,613 \$7,960 4

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