Thursday, October 29, 2009

RRSP and TFSA Strategies

In an ideal world we would all make our maximum RRSP and TFSA contributions each year and look forward to being a millionaire in retirement. However, people who are able to do this are in the minority. Most Canadians have more combined RRSP and TFSA room than they will ever be able to use.

But don’t despair! Having excess room gives us some tax-saving strategies:

Income Smoothing

If your income is highly variable from year to year, you can smooth it out by making RRSP contributions in a high income year and withdrawing some RRSP money in a low income year. This reduces the tax burden if your top marginal rate is higher in the contribution year than it is in the withdrawal year.

One disadvantage of this approach is that the RRSP room will be lost permanently, but this is of little consequence if you have more room than you can use. There used to be another disadvantage before we had TFSAs: any gains on the money withdrawn from the RRSP in the future would be taxed. However, you can now put this money in your TFSA to avoid any future income taxes on your gains.

Tax Reduction for Low-Income Retirees

We’d all like to think that we’ll retire in comfort, but the truth is that many retirees have very low incomes. These people collect the Guaranteed Income Supplement (GIS). In a particular income range, this GIS gets clawed back 50 cents for each dollar of income, an effective additional tax of 50%.

For low-income retirees with a modest RRSP (converted to an RRIF), the required withdrawals each year can be 50% clawed away plus the regular income tax rate. So, some Canadians have more than 50% of their RRSP withdrawals taxed away.

In some cases, it makes sense to withdraw a large amount from the RRIF in one or more years.  Part of each large RRIF withdrawal will be clawed back, but once the GIS is fully clawed back, the remainder of the withdrawal is taxed at a much lower rate.  The result is that you get to keep more of your retirement money.  The downside of this strategy used to be that any future returns on the withdrawn money would cause GIS claw back. But, now, the money can be moved into a TFSA to avoid this problem.


  1. It took me awhile to figure out the last paragraph. I think I see now, that a retiree can take a couple year's living expenses out in one year, and have their GIS clawed back.

    The next year, they can leave all their RSP funds in the plan, and receive their full GIS. Is that right?

  2. Gene: You're right that I didn't explain the idea fully. I've updated that last paragraph to make it clearer (hopefully). Yes, you make a big withdrawal that far exceeds the amount that causes the GIS to be fully clawed back. Once you reach age 71, you can't leave all the funds in an RRIF, and so the idea is to pull it all out in one year, or a few successive years and put it into a TFSA. The only reason to split the withdrawal across multiple years is if the RRIF is so big that one big withdrawal takes you into a high tax bracket. It pays to try out a number of scenarios to get the lowest tax paid.

  3. Thanks for the clarification. I'm a long ways from my golden years, so I haven't looked into that yet. Undoubtedly things will be different in twenty or thirty years.

  4. Michael, I like your thoughts on TFSA and RRSP strategies. Personally, I have come to the conclusion that a TFSA works best for me at this point because I plan to move to a higher tax bracket in the coming years. As a result, I am saving my RRSP credits to apply in the future at a higher net tax savings. I came to this conclusion after assuming an average time value of money vs. the tax benefit.

    Here is a link to one of my articles on the subject that is a basic guide to help individual investors decide whether a TFSA or RRSP is best suited for them personally.

    Keep up the great writing Michael.

    Stuart from