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Striking a balance between RRSPs, TFSAs and non-registered accounts heading into retirement – so funds can be withdrawn in the most tax-efficient manner – is a key challenge, says Evelyn Jacks.KalebKroetsch/istock

With the March 1 registered retirement savings plan (RRSP) contribution deadline approaching, many Canadians will be looking forward to a hefty tax refund in the spring. But for disciplined investors prepared to forgo the gratification of immediate cash, there’s a way to make better use of those refunds.

Namely, put them in a tax-free savings account (TFSA), in which gains on investments are never taxed.

“I consider it using the same dollar twice. Make your RRSP contribution and, all things being equal, use the tax refund as your TFSA contribution,” says Kathryn Del Greco, vice-president and investment advisor at TD Wealth Private Investment Advice in Toronto.

The TFSA is commonly considered a short-term savings tool for vacations, education or emergencies, but the opportunity for it to become a retirement wealth-building tool on par with the RRSP has been growing over the past decade. Since the launch of the TFSA in 2009, the cumulative maximum allowable contribution limit has grown to $63,500. The 2019 contribution limit is $6,000, and Ottawa is expected to continue adding $6,000 plus inflation each year in the future.

“It’s an important retirement tool. Anything that the CRA allows investors to do to protect returns from tax is a wise long-term investment solution for everyone,” Ms. Del Greco says.

According to the Canada Revenue Agency, only 10 per cent of TFSA holders contribute the maximum amount. The TFSA is especially beneficial for millennials saving for retirement because the investments inside, and the tax savings, can compound for decades, Ms. Del Greco says.

“Imagine $6,000 a year growing at an 8- to 10-per-cent rate of return over 50 or 60 years. That could be a really substantial asset for them in retirement,” she says.

Unlike an RRSP, a TFSA contribution cannot be deducted from taxable income. However, withdrawals from a TFSA are never taxed, unlike RRSP withdrawals, which are fully taxed according to the plan holder’s marginal tax rate at the time of withdrawal.

Both savings accounts are permitted to hold just about any investment available on mainstream markets, such as stocks, bonds, options, mutual funds or exchange-traded funds.

Make sure clients are diversified

Maintaining a diversified investment portfolio can be a bit difficult when assets are distributed among an RRSP, TFSA and non-registered accounts. Outside an RRSP or TFSA, half of any gains on equities are taxed, dividends could be eligible for a tax credit, and returns from fixed-income are fully taxed.

Ms. Del Greco’s advice to clients is to ensure diversification takes priority over which account individual holdings are held in, and how they are taxed. That means a mix of fixed-income, equities and cash suited to the personal goals and risk tolerance of each individual client. It also means a diversified mix of equities based on sectors and geographic regions.

“You should be managing your pool of assets as one large lump sum of money and choose the placement of those investments in the account that gives you the best tax treatment,” she says.

Evelyn Jacks, a tax expert and president of Knowledge Bureau Inc., which provides wealth-management education to industry professionals, in Winnipeg agrees that the TFSA has become a potent complement to the RRSP.

“If you make the RRSP contribution and get that tax refund as a result, and you’re disciplined enough to put that in your TFSA, you are leveraging the power of the RRSP,” she says.

Arrange an orderly meltdown of savings

The challenge from a tax perspective, she adds, is striking a balance between RRSPs, TFSAs and non-registered accounts heading into retirement so funds can be withdrawn in the most tax-efficient manner.

“There’s definitely an ordering of meltdown strategies depending on what buckets of money you have, and where,” she says.

That can be difficult because it’s impossible to know how much the investments inside each account will grow over the years.

For example, if investments in an RRSP grow more than expected, some of the funds will be withdrawn in a higher tax bracket. When the plan holder turns 71, an RRSP must be converted to a registered retirement income fund (RRIF), and minimum withdrawals are mandatory. In addition to a higher marginal tax rate, the plan holder could face Old Age Security (OAS) clawbacks if those withdrawals reach a certain threshold.

RRSP, TFSA contribution strategy

Ms. Jacks says the ideal contribution strategy is to put money in a TFSA when a client’s taxable income is low and contribute to an RRSP when the client is in a higher tax bracket. “The higher your income, the more valuable your RRSP tax deduction,” she says.

In addition to an immediate tax refund, she says, RRSP contributions can also create more opportunities to collect benefits and tax credits such as medical expenses, spousal claims and employment insurance, because RRSP contributions count as a deduction, so reduce the income on which those credits are calculated.

“If you’re a younger person and you put the money into an RRSP, you’re going to get the tax savings, but you’re also going to get the reduced net income, which can generate or increase refundable credits [such as] the Canada Child Benefit or the GST credit,” Ms. Jacks says.

RRSP, TFSA withdrawal strategy

The ideal withdrawal strategy at the back end of a retirement plan, she says, allows for RRSP/RRIF withdrawals to be averaged out so clients are in a lower tax bracket each year during retirement, and then clients top up their income as needed with funds from a TFSA to avoid taxation in a higher bracket.

“You want to average down the tax that you pay at the back end, and you can only do that if you plan your withdrawal strategies over a long period of time,” she says.

Another way to reduce the tax bill from RRSP withdrawals is to split them with a spouse in a lower tax bracket, she points out. Income splitting is permitted in an RRSP beginning at age 65, but some company pensions can be split at any time. If RRSP income can be withdrawn at a low rate – whether it is needed or not – she says the TFSA can play a further role in retirement once contribution space is regained.

“Melt down your RRSP in the lowest possible tax bracket, income-split when you can, and stuff that money in a TFSA,” she says.