RRSP vs TFSA: Which should you top up in retirement?

RRSP vs TFSA: Which should you top up in retirement?

The TFSA wins because it’s flexible

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rrsp vs tfsa

Q: I’m a 60-year-old retired school teacher as of this past July 2017. I have $44,000 in unused RRSP contribution room. Should I max out my contribution room on my 2017 taxes? Or just stick to topping up my TFSA?

—Chris

A: Hi Chris. Thanks for the question. Please note that RRSP only counts as a deduction against “earned income” which includes:

  • Net income from employment, business or a partnership;
  • Net rental income from real estate;
  • Disability pensions (issued under CPP or QPP); and
  • Spousal support payments included in your income.

If your income is not from one of these sources it is likely not considered “earned income” meaning your RRSP contribution will not be a deduction. If you do have earned income then let’s note a few things:

  1. The primary goal of using an RRSP is to defer current income to be able to draw that income later in a lower tax bracket.
  2. Income drawn from an RRSP is fully taxable.
  3. Should you pass on, your RRSP will be fully taxed prior to being paid to your estate.

Since you are retired, I am assuming your income will stay fairly constant moving forward and you will not change tax brackets. As such, you are likely unable to take advantage of the tax deferral the RRSP offers. This is illustrated in the example below.

Option #1: Deposit $44,000 to max your RRSP today and deposit the tax rebate into your TFSA today. Let both grow for 11 years until age 71 at which time you must convert your RRSP and begin drawing on it.

Option #2: Deposit $44,000 into your TFSA today and leave it to grow until age 71; at 71 you will not be forced to draw on this money.

Conclusion: Both result in the same end value since you are facing a constant tax rate. Further, your RRSP must be converted upon your 71st birthday whereas you can leave your TFSA to grow for as long or short as you desire. Additionally, it is usually recommended to draw out of your RRSP rather than your TFSA earlier in retirement as your TFSA will incur no tax upon your passing or any withdrawals as compared to your RRSP which will be taxed fully.

What we can conclude is this. If your income will be staying constant throughout your retirement I would advise you to top up your TFSA rather than your RRSP for the following reasons

  • If tax rates increase in the future then you will be taxed at a higher rate upon withdrawal meaning less income in the future. Your TFSA negates the risk of a tax increase.
  • Your TFSA does not force you to pull money out when you are 71.
  • It is always a great idea to have access to a tax-free pool of money to draw on.

I would still suggest topping up your TFSA even if you see your income dropping in the future due to the preferential tax treatment it receives upon your passing and the flexibility it provides as compared to your RRSP.

Andrew Fox is a certified financial planner with Fox Wealth Mangement in Calgary.

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