When it comes to saving for retirement, Canadians have numerous options, including RRSPs, Tax-Free Savings Accounts (TFSA), and Non-Registered Accounts.
Each has benefits, but it’s important to understand how each is treated for tax purposes.
Registered Accounts, such as RRSPs and RRIFs, are fully taxable. Every dollar withdrawn from these accounts will be taxed.
On the other hand, there is no tax payable on withdrawals from the TFSA, and withdrawals from a non-registered account are usually only partially taxed.
Having the right investments in the proper accounts
Due to the reasons outlined above, you would rather have your tax-efficient retirement accounts (TFSA, Non-Registered) grow at a higher rate than your taxable registered accounts (RRSPs, RRIFs).
An Example
Here is a quick example. Let’s say you had $1,000,000, of which $500k was in RRSPs, $400k was in a Non-Registered Account, and $100k was in a TFSA. Let’s also assume you were targeting a return of 4% annually. Would you rather have portfolio A or B
Portfolio A:
$500k RRSPs (Taxable) – 4%
$400k Non-Registered (Tax-Efficient) – 4%
$100K TFSA (Tax-Free) – 4%
Total Portfolio Return – 4%
Portfolio B:
$500k RRSPs (Taxable) – 2%
$400k Non-Registered (Tax-Efficient) – 6%
$100K TFSA (Tax-Free) – 6%
Total Portfolio Return – 4%
Even though both of these portfolios grow at a rate of 4%, portfolio B is preferred, as it grows to a higher value after tax.
How this plays out in reality
I recently sat down with a couple who was approaching retirement. They were looking for a second opinion on their retirement plan, and after speaking with them, it became apparent that they could significantly reduce their tax bill.
Reallocating their portfolios as outlined above would significantly improve their long-term outlook.
Without these changes, they could expect to have $440k less once they turned 90.
That’s a lot of money that could have gone to their kids and grandkids.
Don’t wait until the last minute
The cost of doing nothing compounds quickly as the years go by.
