What's new - or old - this RRSP season
Author: David Aston
Source: The Toronto Star
Expect the pandemic to cause "RRSP season" to play out a bit differently this year.
To be sure, the financial rules around making tax-advantaged contributions haven't changed. Canadians commonly use the lead-up to the annual RRSP contribution deadline as a time to review their investments and top-up tax-advantaged savings. This year the deadline for making an RRSP contribution that can be applied to your 2020 tax return is March 1.
But your best choice on what to do depends on where you stand in the COVID economy. If you've been earning a fairly good salary from a secure job but are stuck at home with limited opportunities to spend it, then this might be a golden opportunity to load up your RRSP with a pile of tax-advantaged retirement savings. On the other hand, if your income has suffered or your job security is uncertain, then it might be better to keep what money you have closer-to-hand in a TFSA.
RRSP vs. TFSA
It's important to understand the distinct and complementary roles played by RRSPs and TFSAs in building your portfolio.
With an RRSP, you get a tax deduction upfront from making a contribution — which generally creates a tax rebate when your 2020 tax return is processed - but the money becomes fully taxable when you withdraw it.
The TFSA functions in the opposite fashion. You don't get a tax rebate on contributions, but you don't pay tax on withdrawals either. (If you're 18 or over, $6,000 has been added to your TFSA contribution room for 2021 and it can be used anytime this year or later.)
But RRSPs and TFSAs also have favourable features in common. Both shelter you from income tax on interest, dividends and realized capital gains while the funds stay invested within the structure of the RRSP or TFSA. Both allow you to accumulate each year's unused contribution room and use it in later years.
When you put it all together, RRSPs and TFSAs work best in different situations.
So if you've spent the pandemic piling up money at home from a well-paying, secure job, then the RRSP contribution is usually the ideal way to put money toward retirement.
If you have built up ample cash during the pandemic and also have unused RRSP contribution room from previous years, then you might be able to make a particularly big contribution. But whatever the contribution amount, it gets you an attractive tax rebate upfront and you're not taxed on the money until you eventually withdraw it in your golden years (at which time you'll probably be in a lower tax bracket).
However, RRSPs usually are not as suitable if you're likely to tap the funds in the near-term, because you'll then get dinged for income tax at what is likely an inopportune time. (There are special exceptions that allow you to withdraw limited amounts from your RRSP without tax consequences for a first-time home purchase or for education, provided you follow specific rules and put the money back according to a specified schedule.)
So if you end up losing your job in the COVID economy and then withdraw money from your RRSP to tide you over until you get another job, you'll probably hate having to pay tax on those withdrawals.
In contrast, TFSA contributions don't get you a tax rebate, but withdrawals never have tax consequences either. Also, if you do tap your TFSA, you don't permanently lose the contribution room (unlike the case for RRSPs). You can put the money back in your TFSA anytime beginning in the next calendar year. Those features make TFSAs a good all-round savings vehicle and far more flexible in case you might need the funds anytime soon. So if COVID has you worried about your financial situation or your job, then the TFSA might be the better place to put your money for now.
The pandemic has demonstrated the value of having an emergency fund that provides three to six months income if needed (although retirees can usually benefit from more). It can make sense to build up the emergency fund within the TFSA, although a nonregistered account can also make sense. Either way, emergency funds should be held in a relatively safe, accessible form, like a high-interest savings account, cashable GIC, or short-term government bond fund. (Keep savings and GICs held at small institutions within deposit-insurance limits.)
One special situation to highlight is that TFSAs are far superior to RRSPs for low-income Canadians, especially if they are likely to remain low income in retirement. In that situation, RRSPs provide only a small tax rebate upfront, but then the RRSP withdrawals in retirement result in a hefty clawback (at roughly the 50 per cent rate) of low-income senior's benefits under the Guaranteed Income Supplement (GIS). In contrast, TFSA withdrawals have no impact on GIS entitlements. In that special case, the RRSP is a poor choice and the TFSA is vastly superior. But in most situations, RRSPs and TFSAs are both good choices. While it makes sense to try to figure out which is most optimal for your situation now, don't let indecision keep you from making a timely contribution to either or both. If RRSPs seem like a reasonable fit, get your contribution in by the deadline.
The pandemic has also impacted the process of making an RRSP contribution. Given mounting second wave restrictions, don't expect to suddenly walk into your bank branch on March 1 to make a spur-of-the-moment RRSP contribution. Fortunately, financial institutions are making it increasingly easy to make contributions online, as well as discuss your investments by email or by phone.
If you're "old school" and want a (masked) face-to-face meeting with your adviser, be sure to book an appointment well in advance. In-person financial services activities are permitted under the new Ontario "state of emergency" rules introduced last week, but expect financial institutions to adopt increasingly stringent and limiting safety precautions until the second wave starts to recede.
Put your RRSP rebate to good use
Making the most of your RRSP contribution doesn't end with you getting your money in by the deadline. You should also make sure you put your RRSP tax rebate to productive use when it comes.
That can help you contribute to both an RRSP and a TFSA this year if you're a bit strapped for immediate cash. Get your RRSP contribution in by the deadline, then use the RRSP rebate to contribute to a TFSA later in the year. But it can also make sense to use the rebate for other productive uses, such as paying down your mortgage.
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