As shown in this post the RRSP tax refund must be fully reinvesting each year if the RRSP is to provide the same income and close to the same capital during retirement compared to a TFSA. Even then, the TFSA is a better retirement option. The spreadsheet used for this analysis can be downloaded so you can try out different conditions such as your own province, marginal tax rate and reinvestment strategy. A major difference between a TFSA and a RRSP is that the RRSP is tax deductible while the TFSA is not and that the RRSP generates a tax refund which depends on your marginal tax rate.
In the 2015 Federal Budget, the minimum payout rates for Registered Retirement Income Funds (RRIF) have been reduced significantly so that capital can be preserved for a longer period of time. The previous post TFSA or RRSP – Impact of Reinvesting the Tax Refund uses the old RRIF Minimum Payout rates and includes a spreadsheet that can be downloaded. Rather than you having to go back to that post, all of the text is given below with changes to include the effects of the new rates, a new section has been added and a new spreadsheet is available.
Wherever relevant, the values from the previous post are shown inside italicized square brackets: [Old rate values: $28K to $19K]. The major impact of the 2015 rates is that using a 5% yearly interest the mandatory payout increases each year rather than decreases as it did with the old rates. This result is the intent of the 2015 rates as described in RRIF Minimum Payout – 2015 versus Old Rates.
Please click on Download Spreadsheet now and open it if you want to use it and to follow along and make the changes indicated below.
The spreadsheet has an entry area and four charts. An explanation of the lines in the entry area as shown on the figure below follows. The lines that have a border and are bold can be changed to new values from those given.
The TFSA (Tax Free Savings Account) has a maximum value each year (for 2015 it is $10,000). To make it easier to compare the changes with the new RRIF rates, the Yearly Amount (1) is set to the $5,500 used in the previous post for both the TFSA and RRSP (Registered Retirement Savings Plan). The marginal tax rate (2) can be whatever value is desired. Refer to the Canadian Marginal Tax Rates – 2014 post to determine your rates. The combined Federal and Ontario rate of 31.15% for income between $43,954 and $80,242 has been used. The tax refund (3) will be $1,713.25. 4) The tax refund (4 & 5) is not reinvested so that the Amount invested (6) for both is $5,500. For a yearly interest rate (7) of 5%, over 30 years (8), both the TFSA and RRSP will have an End Amount (9) of just over $383K.
As you can see, the effect of compounding interest with no taxes being subtracted is very significant as this is over twice the amount that would be invested: the Total Out of Pocket amount invested (10) is $165,000 (5,500 x 30). In addition, the total of all the yearly tax refunds (11) over the 30 years is another $51,397 which can be spent in any way desired. (This needs to be reinvested in the RRSP if it is to provide close to the same capital preservation in retirement as a TFSA as explained later.)
Mandatory Retirement Payout
However, there is a drawback to keeping the tax refunds: withdrawals in any year are fully taxed. Once age 71 is reached, the RRSP must be converted to an annuity or RRIF or taken as cash. For this post, it considered to be converted to a RRIF. The TFSA can continue without any conversion. The yearly interest (12) is again set to 5% but the marginal tax rate (13) is reduced to be the one for income up to $40,120 which is 20.05%.
The resulting Payout and Available funds from ages 71 to 100 are shown in Chart 1. The required minimum payout using the 2015 Rates (and not the old rates) as shown in the dotted red line (RRIF Payout) goes from $20K to $29K at age 94 at which time the payout is set to 20%.[Note that the values using the old rates were $28K to $19K. That is, the 2015 payout profile is the reverse if the old rate, as it increase with time rather than decreases.] The Available funds (payout less taxes at the marginal rate) as shown in the thick black line (RRIF Avail) goes from $16K to $23K at age 94.[Old rate values: $22K to $15K] The TFSA withdrawals are set to be that of the RRIF payout less the taxes. These are shown in the dotted orange line labelled TFSA Avail which exactly overlays the RRIF Available line.
The greatest impact of not reinvesting the tax refunds is shown in Chart 2. The remaining capital for the RRIF (the blue line) decreases each year but the TFSA capital (the red line) stays almost constant. This is due to the fact that the taxes incurred by the RRIF reduce the capital each year while there are no taxes for the TFSA and the withdrawals are always less than the RRIF Payouts. This means that the RRIF is slowly depleted while the TFSA does not change. In essence, more can be withdrawn from the TFSA than the minimum requirement. This is a topic of another post.
Remaining RRIF Capital After Tax Liability
The RRIF capital is not yours to use as you wish. If you withdraw it all in one year, it is all taxed at your marginal tax rate. The dotted black line on Chart 2 shows what RRIF capital would be available after taxes. The spreadsheet contains the marginal tax rates for Ontario and these are used to determine the amount of taxes.
The rates can be changed by opening the Canadian Marginal Tax Rates – 2014 post or associated spreadsheet and copying and then pasting (values only) the From and Fed+Prov columns to the two columns on the spreadsheet for this post.
You might ask what about the $52K of tax refunds that were used during the RRSP years. You had use of this money and it must count for something. One way to deal with this is to consider when the taxes being paid from the RRIF exceed the refunds. At that age the government gets more taxes each year than you got when you kept the tax refund! This is shown in Chart 3 with the Break-even for Tax Refund (14) at age 82 [Old rate value: 80]. Putting it another way, you get to keep about $1,700 each year for 30 years in tax refunds, but the government gets it all back over 9 years after age 71 and then much, much more after that. If you live to after 82, the government wins!
Another question is when does the available fund from the RRIF or TFSA equal what you saved by investing in the RRSP or TFSA during the accumulation phase? This is the Break-even for Out of Pocket (15) which is at age 79 [Old rate value: 78]. This is plotted in Chart 4. That is, after contributing for 30 years, the total amount is returned to you in only 8 years after age 71. After that, you are getting the effect of compounding interest. The longer you live after age 79, the more you make above your initial investment!
Reinvesting All of the Tax Refund
The impact of reinvesting all of the tax refund each year is significant. Changing line (4) from 0% to 100% makes (9) go to over $500K for the RRSP or 30% more than no reinvestment. The resulting charts are given below and the analysis follows the charts.
The required minimum payout goes from $26K to $38K at age 94. The available funds goes from $21K to $30K at age 94. [Old rate value: $37K to $25K and $29K to $20K, respectively.] Compared to no reinvestment, the payout and available funds are 23% higher. [Old rate value: 24%.] The break-even for Out of Pocket (15) has now decreased to age 77. [Old rate value: 76.] The remaining RRIF capital is always higher than that for the TFSA. The TFSA’s capital is exhausted at age 94, but until then the withdrawals exactly match that for the RRIF.
However, when the tax liability is considered, the remaining RRIF capital in any year is less that of the TFSA up to age 92. [Old rate value: 89.] (The dotted black line in Chart 2.) Put another way, the Net Worth (assets less liabilities) of the TFSA is higher than the RRIF because the TFSA does not have any tax liability. After that age, the RRIF has a better Net Worth.
Even when the tax refund is fully reinvested and both the RRIF and TFSA have the same Available funds per year, the RRIF does not preserve Net Worth as well as a TFSA up to age 92.
Note that recent statistics for life expectancy in Canada is 80 years of age for men and 84 for women. However, the probability of living to age 90 is above 40% for people born in the mid-1960s. Thus, it would be prudent to plan for income and capital after age 90. A future post deals with ensuring that the TFSA does not exhaust too soon.
Try out your own situation, such as reinvesting only a part of the tax refund or changing the marginal tax rates to your province and income, by downloading the spreadsheet. You will be able to see what the Payout and Available income during retirement will be for your situation.