Retirement Saving: RRSP/401K or TFSA / Roth Account?


The most common answer given by tax specialists is it depends if you are going to be in a higher or lower tax bracket in retirement. There is little benefit of getting a tax refund if you are currently in a low tax bracket and your RRSP / 401K  withdrawals will put you in a higher tax bracket in retirement.

It may make sense for low income Canadian families to put money into a TFSA because withdrawals are not taxable. The income will not affect their eligibility to receive Old Age Security (OAS) and Guarantee Income Supplement (GIS) from the government. It is also a good strategy for individuals who have a traditional defined benefit pension plan. Withdrawals from a RRSP could reduce their OAS benefits.

However, for the majority of  my U.S. & Canadian followers, I would strongly recommend investing in both. There is no way to predict what your tax bracket will be in retirement. I would first invest the maximum allowable amount into a RRSP or 401k and reinvest the tax refund in a TFSA or Roth account. The compounding effect on even a small yearly refund amount could grow to be quite substantial over the long term.

For example: A 35 year old in a low tax bracket of 20% and has $5,500 to invest per year. Contributing the money into a RRSP or 401K every year would generate a refund of $1,100,  if invested every year in a TFSA or Roth account at 5%  would compounded over 30 years to equal $73,082. To avoid an individual’s tax rate from jumping up into the next tax bracket, they could withdrawal the extra funds from the TFSA or Roth and lessen the withdrawal amounts from the RRSP or 401K. Another option would be to withdrawal the income generated by the TFSA or Roth to pay any extra taxes.

The only problem with this strategy is that most individuals end up spending the tax refund instead of saving it for retirement. People forget that the tax refund is their money, not the governments!

“In the long run, it’s not just how much money you make that will determine your future prosperity. It’s how much of that money you put to work by saving it and investing it.”Peter Lynch (famous retired mutual fund manager and author)

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