SPP or TFSA?

18 Oct

By Sheryl Smolkin

You have $2,500 to contribute to retirement savings in 2012. Should you contribute to a tax-free savings account or the Saskatchewan Pension Plan?

Before answering that question, it is helpful to review some basic SPP and TFSA concepts.

SPP
You can contribute a maximum of $2,500/year to SPP providing you have RRSP contribution room. To find out how much RRSP room you have available in 2012, look at line A of the RRSP Deduction Limit Statement on your 2011 income tax notice of assessment or notice of reassessment.

Your SPP contributions are tax deductible and investment income accumulates tax sheltered. SPP contributions plus interest are also locked in. Unused contribution room is carried forward.

You may elect at anytime between age 55 and 71 to receive an SPP pension or move your SPP account balance into a locked-in RRSP. By age 71, amounts in a locked-in RRSP must be converted to income using a prescribed registered retirement income fund (pRRIF) or life annuity product. You must begin making minimum prescribed withdrawals from your pRRIF in the following year.

Both SPP annuity payments and pRRIF withdrawals are fully taxable income at your marginal tax rate. If your SPP benefits or pRRIF withdrawals push your income over specified limits, a portion of Guaranteed Income Supplement, the age credit and Old Age Security payments may be clawed back.

TFSA
You can contribute up to $5,000/year to a TFSA regardless of your age or income level. Contributions are not tax-deductible. However investment income  (including capital gains), accumulates tax free. When funds are withdrawn from a TFSA, no income tax is payable.

You can withdraw funds available in your TFSA at any time for any purpose — and the full amount of withdrawals can be put back into your TFSA in future years. Re-contributing in the same year may result in an over-contribution amount which will be subject to a penalty tax.

Neither income earned in a TFSA nor withdrawals affect your eligibility for federal income-tested benefits and credits. You can provide funds to your spouse or common-law partner to invest in their TFSA.

By the numbers
All other things being equal, whether or not you will be able to save more in the SPP or a TFSA depends on two key factors.

  1. Your marginal tax rate when contributing as compared to your marginal tax rates when you expect to withdraw the money.
  2. How you use your tax refund.

Generally speaking, if you think your marginal tax rate will be significantly lower at retirement than during your working career, saving with SPP makes much more sense than in a TFSA.

But how you use your tax refund is also important. Canada Revenue Agency calculations when the TFSA was introduced assume the tax refund generated by contributing to a retirement savings vehicle is also contributed to the account.

In these circumstances, investing in either the SPP or a TFSA will result in about the same net withdrawals at retirement. However, many of us look on our tax refund as “mad money” and do not earmark it for further retirement savings. In these situations, the TFSA comes out ahead.

That money can be withdrawn from your TFSA account and contribution room is restored in the next year may be attractive in some cases. However, replacing money you withdrew requires considerable discipline. In contrast, money saved in your locked-in SPP account will be there at retirement when you need it.

Your financial plan
SPP vs TFSA. It’s not an either/or proposition. A financial advisor can review your personal situation and help you decide the best way to maximize your retirement savings.

Depending on your income level, expenses and the amount of income you need in order to retire, you can benefit from having both kinds of accounts plus an RRSP.

To paraphrase David Chilton in TheWealthy Barber Returns:

  1. If you go the SPP* route, don’t spend your refund.
  2. If you go the TFSA route, don’t spend your TFSA.
  3. Whatever route you go, save more.

* Chilton used RRSP in this phrase.

Also read:
Understanding SPP annuities

The Wealthy Barber explains: TFSA or RRSP?

RRSP vs. TFSA: Tim Cestnick on where to put spare dollars

To TFSA or to RRSP?

TFSA vs RRSP – Clawbacks & income tax on seniors

TFSA vs. RRSP – Best Retirement Vehicle?

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