Registered retirement savings plans (RRSPs) have long been the go-to investment vehicle for many Canadians putting away dollars for their golden years. The RRSP offers immediate tax savings when you contribute, lowering your taxable income and sheltering investment earnings from tax as your nest egg grows. The Tax-Free Savings Account (TFSA), since its inception in 2009, works the other way. There’s no tax break when you contribute, but your investments grow tax-free within the TFSA — and you don’t pay tax on withdrawals.
The beauty of the plans is that you can have both — if you’re in a position to contribute — but that may not be possible given all the other demands on your wallet. Maximizing contributions for both plans, though, is probably beyond the means of most Canadians, and choosing between an RRSP and a TFSA is often simply a matter of choosing when to pay the Canada Revenue Agency: now or later.
A simple guideline for selecting which of these two savings tools to use looks at your taxable income, both now and in retirement. If you’re making more money currently than you expect in retirement, the RRSP is your best bet. If your career income is lower than your anticipated retirement haul, max out your TFSA first.
“RRSPs are no longer for everyone,” says St. Catharines, Ontario, financial planner and radio personality David Somerville. “If your income is below $40,000, forget the RRSP.” Somerville points to the effect that RRSP earnings may have on your old age security and the guaranteed income supplement benefits, in some situations: Namely, if you are planning for either an affluent or low-income retirement, RRSP income can trigger recovery taxes of your OAS benefit or a clawback of your GIS amount. This makes a TFSA attractive, since there is no taxable income impact when you withdraw. If you’re earning a high salary now but planning a middle-class-level retirement, the RRSP remains the strongest focus. Still, “the TFSA is the new world of investing, so you don’t always need to follow the old RRSP model,” says Somerville.
Another factor to consider: There’s a big gap between the theory of retirement savings and the discipline required to stay on track. In this regard, the flexibility of the TFSA may offer temptations that jeopardize long-term investment security. Since there is no tax on TFSA withdrawals, there’s less to stop you from raiding your account prior to retirement.
While an RRSP is comparatively more rigid, you can move funds to a homebuyers’ plan or a lifelong learning plan to purchase a home or to continue your education, giving your retirement savings more flexibility without increasing your tax exposure. However, to realize full advantage of RRSP contributions, the current-year tax refund created by these contributions can’t be squandered, and a TFSA may be an ideal place to park those refund dollars (before you’re tempted to spend them), taking advantage of the best features of both plans.