Does it make sense to invest in an RRSP if I will be collecting a Federal government pension when I retire in 25 years? Or should I stick with a TFSA? As of now, my spouse and I have been using our RRSP refund to pay down our mortgage. Please help!
One of my favourite songs to sing is called “RRSPs are the best.” I sing it morning, noon and night, to anyone and everyone, young and old. I’m almost a one-hit wonder when it comes to the best way to save for retirement.
Almost. But not entirely.
I do have a song that I sing for people who have a low income or who will have a solid pension in retirement. That song is called “It depends.”
RRSP or TFSA
For people in the low-income category, say those making under $40,000 a year, there is less to be gained from the tax deferral of an RRSP . And for those who have a defined benefit pension coming to them the TFSA might make more sense than the RRSP for three reasons:
Tax bracket: RRSPs give you an up-front tax refund. Jason Heath, a certified financial planner with Objective Financial Partners, says, “this is always beneficial in the short run, and often beneficial in the long run if you’re in a lower tax bracket in retirement.” But what if you aren’t. And some people who will draw a rich pension in retirement may find that their income doesn’t fall that much when they retire so the lower tax bracket benefit you’re banking on with an RRSP is less compelling.
Guarantee: They already have a retirement income that is almost guaranteed so they may not need the additional retirement savings. (Of course a pension isn’t guaranteed like death or taxes are guaranteed, but from the federal government it is “almost” guaranteed).
Flexibility: A TFSA gives you flexibility. If you think you might need this money for a new car or want it for a vacation, the TFSA will allow you to take the money out without the tax hit that comes with an RRSP withdrawal.
TFSA versus debt repayment
If we say the TFSA wins over the RRSP for those with a defined benefit pension, what about TFSA versus debt repayment? You said you have a mortgage and are being aggressive about paying it down. It might make sense for you to be even more aggressive on debt repayment, says Heath. “I usually encourage those who have pensions to have a slight bias towards debt repayment over investing, since the pension accrual amounts to retirement savings. So someone shouldn’t feel as much pressure to contribute to RRSPs or TFSAs.”
The other argument is that debt repayment has a guaranteed return. The rate of interest you’ll avoid paying by eliminating debt may be more than the returns you earn within your TFSA. That said, in today’s low interest rate environment it is a hard call to make, certainly compared to the days when mortgage rates were in the 8% range and the math made a more convincing argument.
Pension and retirement lifestyle
You should also factor in what sort of lifestyle you and your spouse want to have in retirement and whether your pension will be sufficient to fund it. If your house will be paid off and you have a low-cost retirement planned, the pension may be enough. If, however, you have grander plans to, say, tour the world, you may need to top up your pension income with savings from either your RRSP or TFSA.
There is no clear winner
I have one more thing to say on this point, and it may come across as a cop out. The math on RRSPs versus TFSAs versus debt repayment doesn’t illustrate massive differences. I would continue to focus on exactly what you’re focusing on: Living within your means, paying down debts and saving for retirement—either by being successful in a job that gives you a pension or saving in an RRSP. It is those three behaviours that will make the most difference.