We want to help Canadians by giving a breakdown for the ultimate question in Canadian retirement planning, “Should I contribute to my Tax-Free Savings Account (TFSA) or my Registered Retirement Savings Plan (RRSP)?” We will give you pros and cons of each account and, hopefully, clear up some confusion.  They are both great saving and investing tools for all Canadians, but each can play a different role in your retirement and savings plan. 

TFSA: the Multi-Faceted Savings Account

The TFSA has been around for 10 years in Canada. It took some time to gain traction with Canadians, but it is now a popular investment tool.  It is a great mechanism to save for retirement, especially if you are below the age of 40.  It can be used to garner an extra source of income in retirement, on top of other income flows such as a pension or Old Age Security (OAS) without clawing back either.

The TFSA is famous for its ability to aid in structuring your taxes correctly.  It can be used to place higher-risk investments (rather than in your RRSP) and hopefully higher return investments because you do not pay taxes when you withdraw from your TFSA account.  This means that any compounded growth you receive from investments remains tax free the entire time.  Reinvesting dividends to continually grow your money in your TFSA is another smart way to compound your funds.  By doing that, you will be exponentially growing your long-term investments.  TFSA’s are the perfect account to invest and forget.

There is a maximum contribution limit each year which has been $6,000 for the past three (3) years.  You can check the contribution limit by year on https://www.canada.ca/en/revenue-agency/services/tax/individuals/topics/tax-free-savings-account/contributions.html.  Thankfully, though, your contribution room gets carried over each year, so you never lose it.  It is important to know what your contribution limit is since you will be subject to a fine if you over contribute.  There will be a contribution limit of $120,000 now in a double-income household.

There are some restrictions to be aware of in a TFSA.  For example, you cannot put land, general partnerships or delisted stocks in a TFSA.  If you are a dual citizen with the United States, make sure you speak to an advisor before opening a TFSA since having a TFSA may result in higher taxes payable, and you must report all earnings to the IRS.

Starting your investing and saving as early as possible is key to building considerable returns inside your TSFA.  Don’t be afraid to start contributing small amounts on a set schedule.  This will also kick-start the power of compounding without even having to think about it.

RRSP: The Classic Retirement Account

The RRSP is what every Canadian thinks of when someone mentions a retirement account.  It is the original retirement savings plan created in 1957 by our Federal Government to encourage and incentivize Canadians to save for retirement, and it does a great job.  The RRSP stands out because you receive an income deduction for the amount contributed to an RRSP from the government which can result in a tax refund or credit for whatever amount you contribute.  The tax refund or credit is based on your tax bracket, and it is calculated when filing your tax return each year.   This is like an interest free loan from the Federal Government that is only taken back into income when the amount contributed to your RRSP is withdrawn from your RRSP.

A good way to take advantage of the RRSP is to reinvest your tax refund the next year.  Try not to spend it on a vacation or a new car, but you could put it right back into your RRSP or TFSA instead to get ahead further on your retirement plan.

Some people wonder if it is beneficial to take out a loan for an RRSP.  It depends, if you are in a higher marginal tax bracket, then a loan makes sense if you need one to make a full RRSP contribution.  If you are in a lower tax bracket, maxing out your TFSA is probably more beneficial.  One smart way to use a loan is if your tax bracket is around 40% or higher; take out a loan and contribute it to your RRSP.  When you receive your tax refund, immediately use that refund to pay back part of your loan, then make a schedule to pay back the remaining portion of loan.  That way, you are using your tax refund in a responsible way that is also helping you pay back that loan twice as fast!

With an RRSP, you want to be aware of any consequences for withdrawing money as that amount is included in income when withdrawn.  If at any time you require taking cash out of your RRSP, make sure you speak to your provider or advisor first to see if there is another way to solve your problem.  If there isn’t, come up with a safe way to withdraw that won’t cost you in the end.

When retirement hits and you need to withdraw your money, it is included in income when withdrawn.  At the end of the year in which you turn 71, your RRSP can be automatically converted into a Registered Retirement Income Fund (RIFF) which forces you to withdraw a small amount of your money each year rather than taking all the funds in your RRSP into income in one year.  Be prepared for this, and come up with a plan for your retirement that includes all aspects of contributing, tax advantages, withdrawing, and the expected RIFF rollover.

As with a TFSA, the earlier you can contribute to your RRSP, the better.  In some cases, it may be smart to wait until your tax bracket is a little higher.  The reason is that you want to ensure that you will be in a lower tax bracket when you withdraw the money (compared to when you contributed) in order to efficiently manage your taxes payable. 

The Final Consensus

After comparing both savings accounts, one thing is certain.  It is never too early to start contributing to either, but it is also never too late.  The common denominator between both accounts is that long-term investing is key.  Long-term investment horizons mean a higher amount of compounding which is ultimately what grows wealth the most.  It is also important to focus on the different tax strategies each account offers and which one suits you the best when contributing.  There are many strong features for each account, and it is up to you to take advantage of them!  Set yourself up for success now, and you will thank yourself later.

If you or anyone you know has unused RRSP contribution room, e-mail me at bmoylett@wisdomsi.ca to find out about a complete retirement plan in one simple financial product.  You can also reach me at 778-951-2806.  I would love to help you or anyone you know retire on time.