As veterans of higher education, physicians often anticipate that their children will carry the torch of...
RRSP or TFSA
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RRSPs and TFSAs are both “registered” investment accounts, which means that they receive special tax treatment that is not applicable to other “non-registered” investment accounts.
The special tax treatment of these accounts increases the total benefit of investing by minimizing taxes.
While both accounts are “registered”, they have different tax attributes. Understanding these attributes can help you to determine which account is more beneficial to you based on your circumstances, and in which account to prioritize investing.
Tax Attribute Summary:
RRSP: “Pre-tax” Dollars
RRSP contributions can be deducted on your tax return to reduce your taxable income. This means that they are not taxed when you make the contribution but are taxed when you withdraw the funds from your RRSP in the future (likely in retirement).
TFSA: “After-tax” Dollars
TFSA contributions are made with funds that have already had the tax deducted. These contributions do not reduce your taxable income.
Annual Investment Income
There is no tax levied on the annual investment income earned in an RRSP or TFSA.
RRSPs are taxable to you in the year you withdraw the funds (as you received a tax deduction when you contributed them). Once you withdraw funds, that contribution room does not get reinstated.
TFSAs are not taxable to you in the year you withdraw the funds (you were taxed before you made the contribution). Withdrawals from the TFSA are reinstated as available TFSA room in the following year.
Which account is the most tax efficient to contribute to?
RRSPs typically provide more tax savings to individuals in a higher tax bracket, as the deduction reduces taxable income.
If a physician in the highest tax bracket (~50%), makes an RRSP contribution of $10,000, their tax liability would be reduced by $5,000 ($10,000 deduction * 50% tax rate).
If a resident physician that was taxed at ~35% made the same contribution, their tax reduction would be only $3,500 ($10,000 deduction * 35% tax rate).
In this case, the attending physician saves $1,500 more in tax than the resident physician based on the same contribution amount.
Resident physicians typically begin their careers in a lower tax bracket and advance to high tax brackets when they become attendings.
It can be beneficial for resident physicians to defer the use of their RRSP contribution room (and therefore, deduction) until a future year when they become attending physicians and have higher income.
“Saving your deduction”
Though typically not feasible, an alternative means for residents to receive the higher tax savings is to make the RRSP contributions now and save the deduction for a future tax year to use against higher rate income. This strategy can result in cash flow issues in the year(s) of contribution, as the doctor is still taxed on their total income despite making an RRSP contribution and losing access to those funds.
RRSP Related Programs
Beyond tax savings, there are other programs that are associated with RRSPs which may make contributions in lower tax years beneficial. The two programs that are facilitated through the RRSP are:
- Home Buyers Plan (HBP)
This program allows the borrowing of up to $35,000 from your RRSP account(s) on a tax-free basis with a 15-year repayment period.
Please visit https://bokhaut.ca/fhsaupdates/ for more information on this program’s eligibility requirements and tax implications.
- Lifelong Learning Plan (LLP)
This program allows for loans of up to $20,000 for the funding of qualifying full-time education programs for taxpayers or their spouses and can be utilized multiple times.
Please visit https://www.canada.ca/en/revenue-agency/services/forms-publications/publications/rc4112/lifelong-learning-plan.html for more information.
As noted above, TFSA contributions are made with “after tax” funds. These contributions don’t entitle taxpayers to a tax deduction, so they must pay tax on the income used to make the contribution.
However, individuals do not pay tax on any income earned within the TFSA (interest, dividends, etc.) or on withdrawals from the account.
This typically provides the most tax benefit to individuals who are in low tax brackets now and expect to be in higher tax brackets in the future.
A physician in the highest tax bracket (~50% in Manitoba) would have to earn ~$13,000 and pay tax of ~$6,500 to have enough after-tax funds to make a TFSA contribution of $6,500 ($13,000 income – $6,500 tax).
A resident physician taxed at ~35% would only have to earn ~$10,000 and pay tax of ~$3,500 to have enough after-tax funds to make a TFSA contribution of $6,500 ($10,000 income – $3,500 tax).
In addition to tax-free withdrawals from the account, any amounts withdrawn each year are added back to the taxpayer’s TFSA contribution room in the year following the withdrawal. For example, if an individual withdraws $10,000 from their TFSA in 2023, $10,000 plus the regular annual limit will be added to their contribution room in 2024.
Apart from use of the HBP or LLP programs, TFSAs are better suited for short term savings, as the funds can be more flexibly withdrawn and recontributed. They are also more beneficial to individuals in a lower tax bracket.
RRSPs are more advantageous to doctors with higher income, as the deductions reduce taxable income at high tax rates. Further, contributions are made “pre-tax”, allowing you to contribute more principal to compound over time. This is best when the funds are not needed and can be set aside for many years.
If you are a physician and have questions on the above, please contact us.
* This article was prepared on January 10, 2023. Content is for informational purposes only and is not intended to be used as professional advice. Each taxpayer’s circumstances are unique. Bokhaut CPA makes no representation as to the accuracy and completeness of the information in this article and will not be liable for any errors or omissions in this information.
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