Why the TFSA is Better for Lower Income Canadians
The TFSA is a great savings tool for anybody that doesn't have a pension and doesn't have a lot in their RRSP. It is also a great savings tool for Canadians that make less than the national median wage.
This is a savings tool that if used properly can greatly increase your livelihood in retirement. I am not kidding, this is especially true if you don't have a pension plan and have limited savings.
As we get older, it wouldn't be too uncommon to get a small inheritance or two as your family passes. It is a morbid thought, but it might happen more than once in your life. What to do with that money will depend on your financial health, your current savings, your age and how much you earn.
Credit Card Nerd Math
Most Canadians that are heading into retirement with no employer pension, with little to no RRSPs and no investment accounts will benefit by placing their inheritance in a TFSA over a RRSP.
The claw back of government entitlements is borderline cruel for this group of Canadians. The GIS will pay you up to $773.60 per month, but any dollar you earn in income will increase the claw back on your benefit. OAS benefits are not considered income for the GIS benefit.
Your CPP benefits will vary depending on your contributions, how long you contributed and when you take your first CPP payments. The maximum CPP payment is $1,092.50 a month for 2016, but the average is closer to $600 a month.
Someone that has no other income and expects to get $700 a month ($8400 a year) in CPP will have their $773.60 monthly GIS supplement clawed back to $370.15 a month. Source: http://www.esdc.gc.ca/en/cpp/oas/payments/tab1_23.page
Just so you don't get too stressed out, your total monthly income will be $700 (CPP) + $370.15 (GIS) + $570.52 (OAS) = $1640.67 a month.
At $370.15 a month you will still have $4,441.80 in GIS payments throughout the year. RRSP withdrawals are taxed just like ordinary income and are considered income for the Guaranteed Income Supplement. So if you are making RRSP withdrawals instead of TFSA withdrawals, then you can be paying the equivalent of 63.4% tax.
To keep it simple we will say you live in Manitoba. In Manitoba your combined federal and provincial marginal tax rate will be 25.8%, because you earned $15,246.24 in taxable income ($8,400 CPP + $6,846.24 OAS). A $4,000 RRSP withdrawal will net you $968. ($4,000 x 74.2% + $488 Tax Credit Difference) - (12 x ($370.15 - $204.15)) = $1464. Which works out to a equivalent tax rate of $2,536/$4,000 = 63.4%. There is no tax bracket even remotely close to 63.4%. Note: This is a close, but rough number for your net tax/claw back on your RRSP withdrawal in Manitoba, actual results will vary a little bit.
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A Wake Up Call
If you made an average wage and didn't save much throughout your life, then putting any savings or an inheritance in your RRSP could be the wrong move.
If you saved a lot or at least a decent amount throughout your life, then a RRSP might work out better in the long run.
It doesn't take much to have your GIS completely clawed back and once that happens it is a while before your OAS is clawed back, and at a much more reasonable rate too. An annual income excluding OAS of $17,304 would claw back your guaranteed income supplement completely. If you think that you will make too much to qualify for the GIS, then putting your savings in a RRSP might work better for you, especially if you are in the top income brackets.
If an equivalent 63.4% tax rate won't get you to start doing the math on your own personal finances to see what is the best option for you, I really don't know what else will.
Important Note: If you and your spouse both receive a OAS pension, then the GIS will be completely clawed back when the combined income is $22,848.
$370.15 GIS http://www.esdc.gc.ca/en/cpp/oas/payments/tab1_23.page
$204.15 GIS http://www.esdc.gc.ca/en/cpp/oas/payments/tab1_32.page
Tax rate adjustment: In our Credit Card Math section there was a $503 non-fundable tax credit for non-RRSP tax return that will get cancelled out. On the RRSP return there was $15 less in the MB personal tax credit, because your net income for taxable purposes was higher.
MB Personal Tax Credit http://www.cra-arc.gc.ca/E/pbg/tf/5007-a/5007-a-14e.pdf