Right now, with no income, you’re living in a “tax-free world,” so to speak. If we were in the same situation there would be no need for TFSAs or RRSPs. And it wouldn’t matter if you earned interest, dividends or capital gains—none of it would be taxed.
Unfortunately that’s not the world we live in, and you’ll join the rest of us working, and you’ll be subject to tax, maybe in three years. And this brings us to your question: How to invest today to minimize your future tax liabilities?
Should you contribute to an RRSP or a TFSA?
Remember, when you add money to a TFSA and RRSP, you don’t pay tax on the growth while the funds are held in the account. When you draw money out of a TFSA it comes out tax free, and when you draw money out of an RRSP it is taxable.
The money invested in a TFSA is considered after-tax income, and money invested in an RRSP is considered pre-tax income. You get a tax deduction (refund) on an RRSP contribution but not with a TFSA. That is why you pay tax on an RRSP withdrawal (it was never taxed, and you were given a tax refund on the money) and no tax on a TFSA withdrawal.
The amount of tax you pay on an RRSP withdrawal is based on your total taxable income. The amount withdrawn from the RRSP is added to your other income for the year and then the amount of tax is assessed.
The obvious decision is to maximize a TFSA, which for you would be $81,000, assuming you already hold a TFSA, bringing you up to the $88,000 lifetime contribution limit. You will never pay tax on money in a TFSA. Same for the growth and withdrawals. It will be tax free, even when you have a taxable income.
In addition, each year you can make additional TFSA contributions, currently $6,500. The other advantage is creditor protection should someone sue you, if you can name a beneficiary, and the money doesn’t pass through your estate allowing you by-pass probate, if there is probate in your province of residence.
OK, that’s the easy decision.