How to prioritize your savings; Take the free money

National Post

2011-02-26


With just days left before the 2010 RRSP deadline and various registered plans to choose from, how should you be prioritizing your savings this year?

In an ideal world, you would maximize contributions to all registered plans but this is simply not feasible for most Canadians, who instead need to prioritize to take maximum advantage of all registered plans.

Take the case of Harold, who earns $80,000 annually. He is married to Maude, who currently has no income. They have three young kids.

The couple has the opportunity to save money in a Registered Education Savings Plan (RESP) for all three of their kids and save the balance for retirement through an RRSP or TFSA.

How should they allocate their 2011 registered savings?

To begin with, I've always been a fan of "free money." After all, if the government is willing to give you money to help you save, why not take full advantage of this?

So, my advice would be to begin by contributing to their children's RESP to maximize the 2011 Canada Education Savings Grants (CESGs). By socking away $7,500 (3 X $2,500), the government will contribute $1,500 toward their children's post-secondary education savings. (Note that couples with a disabled child may also wish to investigate the Registered Disability Savings Plan (RDSP), which can also provide generous grants and bonds.)

Where does that leave our couple?

If Harold makes $80,000, pays tax of about $16,000 and puts $7,500 into an RESP, the couple is left with $56,500 from which to pay all of the family's other daily living expenses.

Considering Harold's RRSP contribution limit is $14,400 (18% of $80,000) and his TFSA limit is $5,000 for him and another $5,000 that he could gift to Maude so she could make her own TFSA contribution (ignoring any carry forward of prior years' unused TFSA contribution room), we have total additional available registered savings opportunity of $24,400, after contributing to the RESP.

But clearly the couple, with three young kids, can scarcely afford to save nearly half of their remaining after-tax income of $56,500 in a registered plan, even taking into account the tax reduction by going the RRSP route.

How then should the couple choose between socking any extra funds into an RRSP or TFSA?

While the technically correct answer comes down to comparing Harold's marginal effective tax rate (METR) today with what his or Maude's METR is expected to be upon retirement, provided the funds are left to grow tax-free for the long term in either plan, choosing a TFSA or RRSP is nearly always preferable to investing surplus funds in a non-registered account. Having a discussion with your financial advisor or tax specialist before Tuesday's deadline may help you optimize your registered decision.

So, what will you end up doing this RRSP/TFSA season?