With the introduction of the TFSA as an alternative to RRSPs in 2009, millennials have more to think about than baby boomers did. But the choice may boil down to a comparison of tax rates.
Introduced in 1957, RRSPs offer Canadians three solid benefits, according to a Financial Post
piece by Financial Independence Hub founder Jonathan Chevreau. First, contributing to an RRSP reduces one’s taxable income, which typically leads to a tax refund. Second, RRSP-held securities that earn interest, dividends, and capital gains do not incur tax, so the potential for growth and reinvestment is significant. Third, withdrawing from an RRSP after retirement, during which the user is in a lower tax bracket, will expose them to lower taxes.
The introduction of TFSAs has given millennials an additional choice. Like RRSPs, TFSAs have no upfront tax deduction and shield ongoing investment income. However, TFSA fund withdrawals are not subject to tax.
The younger generation will also get to enjoy an expanded Canada Pension Plan, which was announced last summer and has yet to take effect. “With decent growth from equities, it’s conceivable a millennial who puts $5,500 into a TFSA every year from age 18 on will have $1 million or more by the time he or she reaches retirement age,” Chevreau said. “Even at a conservative 4% return, a $1-million TFSA will spin off $40,000 of tax-free income every year, and you will have the annuity of expanded CPP benefits that will be considerably more generous than they were for the boomers.”
His verdict: “Millennials not yet in a top tax bracket should prioritize the TFSA. They can always carry forward their RRSP contribution room to future years.”
To put it another way, Chevreau cited advice from Tridelta Financial’s Matthew Ardrey. “[A]ll else being equal, if your tax rate is higher now than it will be in retirement, choose the RRSP. If your tax rate is expected to be higher later, choose the TFSA over the RRSP,” he said.
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