Would You Rather Pay Tax on the Harvest or the Seed?

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A question that may come to mind when one is debating on what is the better registered investment vehicle, the RRSP (Registered Retirement Savings Plan) or the TFSA (Tax Free Savings Account) is “would you rather pay tax on the harvest or the seed?”. When looking at the tax deferral aspect of the RRSP, some may say that what good are RRSP’s you pay tax on them when they come out – that’s true but if used properly they come out at a lower tax than when you contributed to them.

For example using today’s numbers. (Assume a taxpayer in Alberta with $120 000.00 in gross income, rate being used is 26% Federal Tax and 10% Provincial Tax).

Joe Albertan contributes $1000.00 when he is in the 36% tax bracket, he would reduce his taxes by $360.00. When he draws it out years later, let’s say a $1000.00 withdrawal in the 25% tax bracket, he would pay $250.00 on this $1000.00 – in this example, he comes out ahead by $110.00 – we are not even factoring in the deferred growth on investments held within the RRSP (the harvest).

On the flip side of the coin using the same numbers.

Joe Albertan decides to contribute the $1000.00 into his TFSA instead. He would pay the 36% tax or the $360.00 and would contribute $640.00 to the TFSA in after tax dollars (the seed). The growth on the $640.00 would never be taxed again (under today’s laws).

It is hard to argue definitively on which vehicle is better because it all depends on the individual’s current tax situation – it is not a one size fits all position. The RRSP would not be of any use to an individual if he or she is in a lower tax bracket now and a higher one when the money is needed, and the TFSA does not offer any tax deferral in the present to those that are in a higher bracket now than they will be in the future. In my personal opinion, if you are in a higher income bracket, it may be best to use both vehicles as the RRSP allows you to save from the first dollar earned (dollars before tax) and move the refund – if any to the TFSA as it is funded with after tax dollars. It is also important to know that each registered vehicle comes with it’s ups and downs which will be summed up in a different post, but based on tax alone “Would you rather pay tax on the harvest or the seed?”