This is where your finance takes place

After the Canadian Government’s create of the Tax-Free Saving Account, many bloggers wrote their thoughts about it. I did a comparison between the RRSP and the TFSA in order to show the advantages and disadvantages of each type of account. However, I don’t think it was clearly showing which account is best. Today, I am doing more calculation in order to see which account gives what at the end of the line.

Assumptions

So here are the numbers I worked with: You can save up to 5k per year for the next 25 years. You think you will earn an average yield of 7% during that period. Your marginal tax rate is 38% and you will reinvest your 1^st and 2^nd tax return into your RRSP plan (38% of 5K is $1,500 and 38% of $1,500 (only starting the second year) is $722). After 25 years, you will get either $338,382 in your TFSA or $503,499 in your RRSP. For calculation detail, please look at the chart below:

 

Year	TSFA Contribution	RRSP Contribution	RRSP Return (Reinvested)	RRSP Return #2 (Reinvested)
1	5 350,00 $	5 350,00 $	1 900,00 $	0
2	11 074,50 $	11 074,50 $	3 933,00 $	772,54 $
3	17 199,72 $	17 199,72 $	6 108,31 $	1 599,16 $
4	23 753,70 $	23 753,70 $	8 435,89 $	2 483,64 $
5	30 766,45 $	30 766,45 $	10 926,40 $	3 430,03 $
6	38 270,11 $	38 270,11 $	13 591,25 $	4 442,68 $
7	46 299,01 $	46 299,01 $	16 442,64 $	5 526,20 $
8	54 889,94 $	54 889,94 $	19 493,62 $	6 685,58 $
9	64 082,24 $	64 082,24 $	22 758,18 $	7 926,11 $
10	73 918,00 $	73 918,00 $	26 251,25 $	9 253,48 $
11	84 442,26 $	84 442,26 $	29 988,84 $	10 673,76 $
12	95 703,21 $	95 703,21 $	33 988,06 $	12 193,46 $
13	107 752,44 $	107 752,44 $	38 267,22 $	13 819,54 $
14	120 645,11 $	120 645,11 $	42 845,93 $	15 559,45 $
15	134 440,27 $	134 440,27 $	47 745,14 $	17 421,15 $
16	149 201,09 $	149 201,09 $	52 987,30 $	19 413,17 $
17	164 995,16 $	164 995,16 $	58 596,41 $	21 544,64 $
18	181 894,82 $	181 894,82 $	64 598,16 $	23 825,30 $
19	199 977,46 $	199 977,46 $	71 020,03 $	26 265,61 $
20	219 325,88 $	219 325,88 $	77 891,44 $	28 876,75 $
21	240 028,70 $	240 028,70 $	85 243,84 $	31 670,66 $
22	262 180,70 $	262 180,70 $	93 110,90 $	34 660,14 $
23	285 883,35 $	285 883,35 $	101 528,67 $	37 858,89 $
24	311 245,19 $	311 245,19 $	110 535,67 $	41 281,56 $
25	338 382,35 $	338 382,35 $	120 173,17 $	44 943,81 $

 

Retirement

So let’s pretend that you don’t earn any other income but the one received from your TFSA or RRSP (it might be the very truth because of the babyboomers, who knows?). Since you are retired, your investment return should drop to 5%. If you withdraw 25K net of taxes, you would be able to do it for 23 years with the TFSA and 25 years with the RRSP (we have to count that you will withdraw at an average rate of 30% since you don’t have any income).

However, if you have other source of income (government’s pension, employer’s pension, rental properties, etc.) and you are still at 38% marginal tax rate, your RRSP account will only last 20 years.

The Conclusion

I would declare the TFSA the winner for the following 2 reasons;

- TFSA provide the contributor much more flexibility and withdrawals are tax free.

- RRSP accounts are competitive if you pay less than 32% average tax rate and you must invest all your tax returns into your RRSP in order to have these numbers. Then again, the TFSA is much more flexible.

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Say what? You didn’t contribute to your RRSP account yet? Well you still have another 10-12 hours to do so. Today, most branches will open their doors all day in order to get as much RRSP contribution possible.

What’s funny is that the RRSP campaign starts in late November in the financial industry but no matter how much effort they put into advertising, the best RRSP period is always the last week of February. So here are some tricks for a last minute contribution.

 

Be ready

Take a quick look at your budget and you chequing account. You will have a better idea if you can contribute form a line of credit or your bank account. If not, you have the possibility of having an rrsp loan. It is still not too late to get approved for an rrsp loan. You can always go with the bank’s pre approved program which takes 10 minutes to complete.

If you don’t know if you can contribute or not, just bring your 2006 Notice of Assessment to your advisor. He will show you how to calculate it (it’s at the bottom of this document).

Don’t invest right away

Both you and your banker have no time to review your investment profile and your risk tolerance. The important part today is to get the money into an RRSP account. So you can simply deposit the money into your existing RRSP account and schedule another meeting in March in order to make a wise investment. You will avoid making stupid decisions and your banker will thank you to save him time on his busiest day of the year.

You still better off to schedule a meeting

If you get there last minute without a meeting, your advisor might not be able to find enough time to meet with you. If you call this morning and ask him, he will surely find a spot between two clients at one point in time. You could be surprise how flexible people can be at that period of the year.

Don’t skip your RRSP contribution

If you skip your RRSP contribution this year, you will miss a real good opportunity to invest when the markets are down. In addition to that, the power of compounding interest will loose a year in order to work out its magic.

Prepare yourself for next year

All right, you are last minute this year but this could be a different situation next year. While you are planning a second meeting with your advisor in order to invest your money, why don’t you ask him how to avoid this kind of stressing situation? He will surely has some trick to show you.

So pick up the phone, schedule a meeting and get some RRSP contribution today before it’s too late!

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image source : geocities.com

Believe it or not, there are still advantages of contributing to your RRSP even if you have a low income. I know that, most of the time, when you income is low, there is no place for savings. However, some people are very disciplined and frugal (not like me!) and they still manage to put a few bucks aside. Then, they decide to put into their bank account since they would not get a high tax return. So here are some reasons why you should contribute as early as possible.

You can defer your tax return

Many people think that when they receive their RRSP slip, they have to put the full amount in their income report. In fact, you have to choice of contributing right away but using your tax deduction for another year. Therefore, your investments will still qualify as RRSP’s but you will not get a tax return on the very same year. You are allowed to defer your tax reduction later on in order to benefit from a bigger tax return. This method is especially efficient for student who has a small income but will surely hit bigger tax brackets when they start working full time.

Your investment still grow tax free

An RRSP account is a tax sheltered account where you are allowed to deposit money. Even thought you did not ask for your tax return, your investment will still grow in a tax free environment (I wish I could live in such environment!) So interest income, dividends or even capital gains stay fully invested in your RRSP account and you don’t have to pay taxes on it until the day you start withdrawing. Isn’t life beautiful?

The power of compound interest

I wrote a post a while ago about what Einstein qualified as “the most powerful discovery”. Did you know that if you invest $1000 at the beginning of the years for 30 years at 7%, you will get $101,073 in your RRSP account? Then, if you wait 10 years before contributing, you would have to put $2,465 (so 2,5 times the original amount) over 20 years to get to the same result. This would result into a total contribution of 30K in the first scenario and 49K in the second one for someone who waited 10 years before starting to contribute.

The bottom line is that you must contribute as fast as possible in order to have a nice nest egg when you retire. Don’t wait until you’re in the highest tax bracket. Invest now, benefit from the tax sheltered environment and the power of compound interest; you will have plenty of time to claim your tax return later on!

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