Why 2022 is a year to dig deep for contributions to RRSPs and TFSAs

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Make 2022 a year you go big on contributions to TFSAs and RRSPs.

There’s a unique opportunity to build wealth for yourself, and do some public good. A lot of cash savings have piled up because of the pandemic. If it all gets spent, inflation worsens and interest rates will have to rise a lot.

Solution: Divert some cash into registered retirement savings plans and tax-free savings accounts.

Bank of Canada Governor Tiff Macklem explained the link between spending and rate hikes in some remarks to a Senate committee last week. As reported by my colleague Mark Rendell, Mr. Macklem told the senators it’s clear that interest rates need to be on a rising path. “The slope of that path is going to depend on economic developments, and if consumers spend more, the slope of that path will likely have to be steeper,” he said.

Look, the economy needs the lift of more consumer spending. And we’ve all been ground down in the past two years – some retail therapy seems justifiable if you’re part of a household that wasn’t financially crunched by the pandemic.

But inflation is running at a 30-year high of just below 5 per cent and interest rate increases will start as early as next month. The last thing we need is a national spending eruption that pings Mr. Macklem’s radar and leads to still more rate hikes.

According to an early February estimate from RBC Economics, there’s a bit more than $100-billion in additional savings than there would have been without the pandemic lockdowns and restrictions of the past two years. A lot of the cash parked during lockdowns and restrictions is sitting in bank savings accounts earning little or nothing. A best case is a rate of 1 to 1.5 per cent, which is tolerable if your goal is to keep money safe as a Plan B fund for emergencies.

For cash that you don’t need in the near term, consider dividing money between some judicious spending and contributions to RRSPs and/or TFSAs.

The deadline for RRSP contributions that count toward your 2021 tax return is March 1, while TFSA contributions can be made any time. If you use Canada Revenue Agency’s online My Account service, you can look up your accumulated personal RRSP and TFSA contribution room.

Taxes are a big factor in deciding whether to contribute to an RRSP or TFSA. Younger people who aren’t yet in their peak earning years will likely get the best after-tax result from a TFSA. Contributions to TFSAs are made with after-tax dollars – this money and the investment gains it generates can be withdrawn tax-free at a future date. The amount of tax you avoid on a TFSA withdrawal several years from now could be higher than the tax rate applied on your income today.

Peak earners could be better off contributing to an RRSP on an after-tax basis. The tax break they get for an RRSP contribution in 2022 would in many cases exceed the taxes applied on withdrawals from the RRSP in retirement.

With the pandemic dragging on, there’s a practical spin on TFSAs and RRSPs as well. TFSA money is readily accessible – you can often transfer money out of a TFSA held at a bank or investment firm into your chequing account in 24 to 48 hours. Money can be withdrawn from an RRSP, but you should expect to fill out forms, pay withholding taxes and wait a while for your money to arrive.

It’s not an ideal time to invest RRSP or TFSA money in the stock market, but when is it ever? Stocks have been flying for the better part of two years and a downturn will come at some point. For now, some market strategists see upside in particular for the Canadian stock market, which hasn’t gone up as much as its U.S. counterparts.

Suggestion for an RRSP or TFSA investment that won’t be needed for at least five to 10 years: Pick a kind of exchange-traded fund, or ETF, called an asset allocation fund. Think of these as a fully diversified portfolio in a box, with variations for investors of all ages and risk profiles. For ideas on brokers where you can buy asset allocation ETFs, try the latest Globe and Mail digital broker ranking.

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