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Consider these five factors before deciding whether to contribute to a registered retirement savings plan (RRSP) or a tax-free savings account (TFSA).
Photo by Arif Riyanto on Unsplash
One of the most common questions out there is whether to invest in a registered retirement savings plan (RRSP) or a tax-free savings account (TFSA). Both will help you save, and save on taxes, but each works in a different way. Understanding how these accounts work will help you decide which is best for your current needs—and even when to use them in tandem.
A TFSA (or tax-free savings account) is a registered investment savings account that any Canadian resident, aged 18 or older, can use for straightforward savings or to hold investments. It can store things like exchange-traded funds (ETFs), guaranteed investment certificates (GICs), bonds, stocks and cash.
Any income earned in the account—even when it is withdrawn—is tax-free. This means any interest, stock dividends and capital gains earned in your TFSA aren’t subject to income tax. However, your TFSA contributions won’t reduce your taxable income like RRSP contributions will.
There’s a limit on the amount of money you can contribute to your TFSA is annually. However, you can carry forward the unused contribution room to a current lifetime maximum amount. Each year, you get an allotment of around $6,000 available for your TFSA, which means that you can put that amount away, plus any rollover from previous years (to find out how much room you have left, use this contribution room calculator).
So how is a TFSA tax-free? The money you put into this account has already been taxed—you contribute to a TFSA from your net income—so there’s no tax break at the time of contribution. But, any gains you earn in a TFSA—whether it’s from a savings account, a high-growth index fund or another investment product—aren’t subject to capital gains tax, so you won’t owe any tax on your earnings when you make a withdrawal. Plus, any gains you earn on those investments will not affect your contribution room for the current year or years to come, either. Essentially, you don’t pay tax on the money you make in your TFSA.
A registered retirement savings plan, or RRSP, works similar to a TFSA, in that it can hold savings and investments. A significant perk of this account is that it allows you to contribute a large amount of money each year, and it reduces your taxable income based on how much you contribute. In this way, an RRSP allows you to defer your taxes while saving for retirement. For 2021, the RRSP contribution limit is $27,830; for 2020, it was $27,230; and for 2019, it was $26,500.
An important thing to note is that you will pay tax on this money once you withdraw it. When you turn 71, you can no longer contribute to your RRSP and must convert it into a registered retirement income fund (RRIF) that you can withdraw from. This is when you’ll start paying tax on the money you contributed. However, the idea is that, because you will be retired, you will be in a lower tax bracket than during your high-earning years, which means you will have paid less tax overall because you invested in an RRSP.
The best investment for you is going to depend on your individual financial situation and goals. Remember: With a TFSA, you pay tax on money you’ve earned before you make a contribution, and with an RRSP you get a tax refund now on money you contribute, but will have to pay tax later, when you withdraw money from the plan. This difference, along with your income, your investment timeline, and other factors will all contribute to making the right decision for your investment dollars. You may find that you can use both vehicles simultaneously. So, is it better to max out your TFSA or your RRSP? Read on to learn more.
Your income determines your tax bracket—the amount of income tax you have to pay—and these factors will strongly influence which investments work best for you.
As a general rule, those making more than $50,000 annually will do well to invest in an RRSP. This is because the money you put in is tax deductible and your deductions go towards reducing what you owe. For those who make less than $50,000 per year, the deduction is less valuable, because after claiming basic tax credits, you aren’t likely to owe much income tax. In these cases, putting your money into a TFSA may make more sense. Here’s a chart of the Canadian tax brackets to help you determine yours:
| Annual Income (Taxable) | Tax Brackets | Tax Rates | Maximum Taxes Per Bracket | Maximum Total Tax |
|---|---|---|---|---|
| Up to $49,020 | The first $49,020 | 15% | $7,353 | $7,353 |
| $49,020 to $98,040 | The next $49,020 | 20.5% | $10,049.10 | $17,402.10 ($7,353 + $10,049.10) |
| $98,040 to $151,978 | The next $53,938 | 26% | $14,023.88 | $31,425.98 ($17,402.10 + $14,023.88 |
| $151,978 to $216,511 | The next $64,533 | 29% | $18,714.57 | $50,140.55 ($31,425.98 + $18,714.57) |
| Over $216,511 | Over $216,511 | 33% | n/a | n/a |
Compare the best TFSA rates in Canada
Anytime you make an investment, it’s a good idea to identify exactly what you’re saving for. Putting away money for retirement is usually on a longer timeline than, say, your child’s education fund or a home renovation.
Your RRSP money is earmarked for your retirement. The program is designed so that when you withdraw the money you will be earning less, and will therefore find yourself in a lower tax bracket, meaning you will pay less overall tax in your lifetime. This works well for its intended purpose but does not help you with short- or medium-term goals. That’s where a TFSA might work better, given that you can make withdrawals tax-free, and with no penalties. Money invested in a TFSA could easily be withdrawn to buy a car, for example, with no tax implications.
Compare the best RRSP investments*
If you receive a matching contribution from your employer on a group RRSP or a similar tax-deferred account like a defined contribution (DC) pension plan, investing in your RRSP could be even more valuable than usual. The way employer contributions tend to work is that your company will match a percentage of your salary when you invest the same percentage, or a percentage of what you contribute—sometimes dollar for dollar. This free money is an automatic return on your investment that would be pretty much impossible to obtain through investing.
Let’s look a little closer. An employer match of even 2% on a $70,000 income results in an extra $1,400 in your RRSP—and your employer’s portion of the contribution may also count towards your RRSP deduction for tax purposes. This is a double benefit and will likely tilt your preference in favour of a workplace account over other savings options unless the match is low, or the investment options are terrible.
Remember how your RRSP is designed for your retirement? There are a few notable exceptions to that, in the form of the Home Buyers’ Plan, and the Lifelong Learning Plan.
The Home Buyers Plan (HBP) allows eligible home-buyers to withdraw up to $35,000 from their RRSP to put towards their purchase. The withdrawal is tax-free and must be repaid within 15 years. This is a great way to access a large lump sum, like for a down payment, and though it must be repaid, the “loan” is interest-free.
Similarly, the Lifelong Learning Plan (LLP) is a program that allows you to use your RRSP savings towards your own (or your spouse’s) full-time education or training, up to $20,000 over two years. The amount must be repaid within 10 years.
When saving and planning for retirement, it pays to take a considered and long-term approach with your decisions—and to personalize them. Whether on your own or with a professional, retirement planning can help validate your choices and assist you to set targets for the future.
Almost always RRSPs (but it depends on your income, as covered in section 1).
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I’m 65 and just 4 years ago i started putting money into an rrsp. i have a little over 15 grand. i also have a tfsa but its much lower at about a grand. I’m tempted to take my rrsp’s and put them in my tfsa.
Can someone tell me if this would be a smart thing to do, after all i believe your not taxed on tfsa’s
Thnx, ray
HI Ray, thanks for asking.
Due
to the large volume of comments we receive, we regret that we are unable to respond directly to each one. We invite you to email your question to [email protected],
where it will be considered for a future response by one of our expert columnists. For personal advice, we suggest consulting with your financial institution or a qualified advisor.
As my husband and I are very close to retirement we were wondering if this 4% rule is based on your cash portfolio (RRSP’s, TFSA and Investments) or is it based on your entire asset portfolio, RRSP’s, Investments, TFSA, and Real Estate holdings (primary and other).
Thanks
Gail
Response from the MoneySense editorial team:
Hello Gail, thank you for asking.
Due to the large volume of comments we receive, we regret that we are unable to respond directly to each one. We invite you to email your question to [email protected],
where it will be considered for a future response by one of our expert columnists. For personal advice, we suggest consulting with your financial institution or a qualified advisor.
Thank you! Very clear and concise explanation. Love this article!
You won’t necessary pay taxes on RRSP withdrawals if you are under your personal credits. ie: A senior couple can have an income of 46k (50k by 2023) before paying any tax
Good discussion, but I have issues with #5. The TFSA is ALWAYS better in retirement. For example, a $5,000 RRSP withdrawal will result in 20% or more in tax, leaving $4,000 to spend. A $5,000 TFSA withdrawal will provide $5,000 to spend, completely tax free!
In any case, you cannot make the assumption that you will be in a lower tax bracket at retirement, as seniors’ tax rates are generally much higher at lower income levels than rates at pre retirement. The income tax rate approaches 50% once retirement income exceeds $79,000, due to the impact of the OAS clawback.
I’m 18 and just started university. I want to get ahead in my savings for my retirement as well as savings for a house for the future. I’m really struggling to figure out which one to start. Should I do both?
Due to the large volume of comments we receive, we regret that we are unable to respond directly to each one. We invite you to email your question to [email protected], where it will be considered for a future response by one of our expert columnists. For personal advice, we suggest consulting with your financial institution or a qualified advisor.
“Tip: If you find that you have a tax refund, you can maximize it by reinvesting the balance into a TFSA.”
If you have space in both RRSP and TFSA why is it preferable to invest the refund I be a TFSA?
There should be a section on which is best when you pay into a pension plan through work and expect to receive a pension upon retirement. I believe this tilts the decision towards TFSA to a much higher salary than $50,000.
This is a decent guide, but things are unfortunately a bit more complicated than this. For many people, the TFSA is the better option, even in some situations where it says otherwise in this guide.
For example, in #2, it may very well be to your advantage to invest for retirement in a TFSA if you have a long time horizon. This is because the compounding interest won’t be taxable on the way out. E.g.: say you’re 30, and you have $2500 to invest. At 7% compounding interest for 35 years, this will grow to almost 28,000, with 25,500 of it being sheer interest! Well, in your TFSA, that 25,500 won’t be taxable when you take it out. But in an RRSP it would be. Even with a very low taxable rate of ~20% on the way out, you’re paying $5000 in taxes! This dwarfs any “savings” you get from investing pre-tax now, even accounting for different tax brackets.
Secondly (and this is criminally underreported), folks who don’t expect to have or make a lot of money in retirement should almost always invest in a TFSA. This is because withdrawals from your TFSA don’t count as income for tax purposes, but RRSP withdrawals do. And because it counts as income, it lowers your eligibility for things like the Guaranteed Income Supplement. You are literally working against your ability to receive GIS support by investing in a RRSP instead of a TFSA if you aren’t a person of means; see research and articles by Richard Shillington.
In other words, if you have a very long investment horizon, or if you don’t expect to have a lot of income upon retirement, the TFSA is likely to be better for you. The RRSP is useful primarily if:
– you’re able to get employer matching through it (obviously)
– you believe you’ll be buying a home soon through HBP
– you’re in a higher tax bracket and expect to be so even in retirement; or
– you don’t have a long time investment horizon
In most other cases, the TFSA is more useful in the long-term as well as short.
RRSP’S – THE BIGGEST SCAM GOING
I have maintained for years now that the RRSP is the biggest scam going. You are seduced by a “tax refund”, which you often spend anyway. You lock up money that is not guaranteed to compound at a rate anywhere near the rate at which it will be taxed down the road.
RRSP’s serve one main purpose, to ensure the government will continue to collect tax after age 71. If the annuitant has no spouse due to death or divorce, upon death the CRA considers all assets in the RRSP deemed to be sold as INCOME and taxed in the year of death. So, you see an elderly person with good intentions of leaving their children a sizeable inheritance is duped. This is because the taxes on say a $200,000 RRSP in Ontario, Canada, will be taxed $72,773. That means that the net amount left is $127,227. The average tax rate is 36.4%. Basically this means many years of earned returns have evaporated instantly in a puff of smoke.
If you have a considerable amount of assets in your RRSP you also risk losing other “free” government benefits such as OAS, GIS, and Drug Benefits due to CRA claw-back provisions. It’s a no-brainer. Choose TFSA and avoid getting burned by the CRA.
Robert Botnick
CANADIAN CENTS I.Q.
This article did a great job explaining the different options in everyday term.
We have an abundance of people in their 40s and 50s without enough money for retirement. This is why I always prefer RRSPs – we are kit good at saving. A 25 year old today will have to easy access to money in any TFSA; they may put it in a TFSA for retirement, but life over the next 40 years will have something to say about that, and there will always be someone presenting a good case to spend the money. That is a lot harder with an RRSP. If it is retirement savings, use an RRSP and don’t delude yourself into thinking you can save for retirement using a TFSA. You will get old ( the only certainty here), and TFSA money will likely be spent.
There is no right or wrong answer. If you make $50,000 to $90,000 or more a year RRSP’s can give you a good tax deduction if you invest enough to lower your tax burden and the return you get can go into a TFSA if you like. I get $3K to $4K back each year due to RRSP contributions, then invest my return into my TFSA. So I am able to put into my RRSP and TFSA. If I did not contribute to RRSP’s then I would not get $3-$4K back each year and would likely own money to Revenue Canada each year. Both have their upsides. Not all investment assets for example are eligible to reap the tax-sheltered benefits of TFSAs. TFSAs are required to limit their holdings to qualified investments. You have much more asset diversity with RRSP’s verses TFSA. For example dividends issued from a US-listed stock or ETF may be subject to a non-resident withholding tax of generally 15% (levied by the IRS- the American revenue regulatory body). I think the article gives a basic view of what to consider with each option. My suggestion is to do more research and educate yourself on the topic. Most people also make less in retirement from all sources of income eg: CPP, OAS, RRSP’s, etc.. so are often in a lower tax bracket verses their working years. Either way saving for the future via RRSP’s or TFSA is a good thing as many people do not start saving until later years after their mortgage is paid off , kids completed University, etc… Start early and contribute regularly and don’t just keep money in a high interest savings account as you will only loss money with interest rates well below inflationary rate.
Its so annoying when I hear people talk about RRSP’s being a scam or blaming governments for their own mistakes and or not putting a little away each pay check. Think its time people (not everyone but these in particular) to look in the mirror and start taking responsibility. I’m fortunate in that I’ve always had common sense and logic, and quickly found out at a young age that compound interest should be added as one of the worlds great wonders. I was a high school dropout but worked hard and made my way, not with a huge salary but just realized the power of putting a little away. I also realize that life happens and for some, its not so easy and wish the best for them. However, shame on those who could save but don’t but then complain and blame others. Very sad.