Should You Put Your Savings in a TFSA or RRSP?
2019 is fast approaching, and with it, our Registered Retirement Savings Plan (RRSP) and Tax-Free Savings Account (TFSA) contribution room will grow to accommodate another year of saving for retirement. In 2019 you’ll get another $6,000 in contribution room in your TFSA, and your RRSP contribution room will increase by 18% of your earned income in 2018.
In an ideal world, we’d all contribute to both our TFSA and RRSP. Our financial plans would include making the maximum contributions to both accounts, putting us on the path to well-funded early retirement. But if you’re like most Canadians, you probably don’t have the money to max out both your TFSA and RRSP, and you’ll have to decide whether to put your savings in an RRSP or TFSA.
RRSPs and TFSAs have been the subject of comparisons since the TFSA was introduced in 2009, and it’s easy to see why. These two registered accounts have a lot in common:
- Both are tax-sheltered and are a good place to grow your long-term savings
- Both accounts have contribution limits set by the government
- Both accounts can hold cash, GICs, equities, fixed income assets, or electronic exchange funds (ETFs)
- Both accounts allow you to carry forward unused contribution room to future years
It’s been almost ten years now since the TFSA was introduced, and clear trends are emerging on who is using RRSPs or TFSAs. According to 2016 census data, younger Canadians are more likely to contribute to TFSAs, and Canadians aged 35 to 54 are more likely to contribute to RRSPs. This data gives us an important clue as to which accounts are appropriate for each age group.
Generally speaking, you will benefit more financially if you contribute to your RRSP when you are earning more than you would in retirement, as is the case with the 35 to 54-year-olds mentioned above. If your income is lower now than you hope it will be in retirement, TFSAs have some benefits that make them the more attractive choice.
Comparing the TFSA vs RRSP
Before we dive into the nuts and bolts of whether an RRSP or TFSA is the right place for your savings, let’s look at the main differences between the accounts:
|Contributions are tax-deductible||Yes||No|
|Contribution limit||18% of earned income from the previous year||$6,000 per year in 2019|
|Withdrawals are taxed||Yes||No|
|Youngest age for contributions||None||Age of majority (18-19)|
|Oldest age for contributions||71||None|
There is a lot to unpack here, but the biggest and most important difference between the two retirement accounts is how your contributions are taxed.
With an RRSP, your contributions count as a deduction against your income, which earns you a tax refund in the year you claim your contribution. The taxes are then applied when you withdraw the money, usually in retirement.
TFSAs, on the other hand, do not earn a deduction when you contribute, but there is also no tax owing when you withdraw the funds in retirement.
This difference might seem small, but it makes a big difference depending on your tax bracket. If you contribute to an RRSP when you are in a higher tax bracket than when you withdraw the funds (at retirement), you’ll pay less tax overall.
If you’re in a lower tax bracket now than when you retire, you’ll pay less tax overall if you contribute to a TFSA instead.
Verdict: If you’ll earn more in retirement than now, go with a TFSA. If the opposite is true, choose an RRSP.
Both the RRSP and TFSA have contribution limits, which is the amount you can contribute each year without incurring penalties. The contribution limits for these two accounts are different and benefit different individuals.
The RRSP has a contribution limit of 18% of the previous year’s earned income, up to a maximum amount. According to the Government of Canada, 2019’s maximum contribution limit is $26,500. This generous contribution limit makes an RRSP a good choice if you earn a high income, because you’ll benefit from saving more.
The Government of Canada set the TFSA contribution limit to $6,000 in 2019, and, unlike the RRSP, TFSA contribution limits are the same no matter what your income level. That means someone earning $100,000 per year and someone earning $25,000 per year have the same contribution room. Here is a side by side comparison of the two contribution limits depending on income:
|Annual Income||RRSP Contribution Limit||TFSA Contribution Limit|
|$100,000 per year||$100,000 x 18% = $18,000||$6,000|
|$25,000 per year||$4,500||$6,000|
Verdict: If you are young and aren’t earning a lot of money right now, or you’re a freelancer and your income varies from year to year, you’ll have more contribution room in your TFSA.
Withdrawing money from your RRSP or TFSA may seem a long way off, but now is the time to consider how using your retirement money will affect your finances—especially your government benefits.
When you withdraw money from your RRSP in retirement, it counts as earned income and you’ll pay tax on it. Earned income in retirement could trigger a reduction in seniors benefits including Old Age Security or Guaranteed Income Supplement.
In 2018 the threshold for the Old Age Security clawback was $75,910. That means that if you plan to retire and withdraw that amount or more from your RRSP annually, you’ll have to repay part of your OAS pension. The amount you’ll have to pay back is equal to 15% of the amount you exceed that threshold.
For example, if you plan to retire and withdraw $90,000 from your RRSP every year, you’ll have to repay:
$90,000 – $75,910 x 15% = $2,113.50
TFSAs, on the other hand, do not incur clawbacks because withdrawals are not considered taxable income.
Verdict: If you plan to retire with a very high income, prioritize your TFSA.
RRSP or TFSA for Other Savings Goals?
So far, we’ve focused mostly on the TFSA vs RRSP as retirement savings accounts, but what about using these accounts to save for other goals?
RRSP Non-Retirement Uses
Home Buyer’s Plan (HBP) – Your RRSP can help you save for your first home. Under the Home Buyer’s Plan, first-time homebuyers can borrow up to $25,000 from their RRSP without incurring any penalties. The money is considered a loan from yourself and must be paid back over several years.
Lifelong Learning Plan (LLP) – Planning to go back to school to upgrade your education? The LLP lets RRSP holders borrow up to $20,000 ($10,000 per calendar year) for you, your spouse, or your common-law partner to finance full-time training or education. Payback terms are similar to the HBP.
While many personal finance experts lament the fact that Canadians routinely raid their RRSPs to pay for things like first homes and education, if you intentionally save within your RRSP for these big-ticket purchases, you can use your contributions to maximize your income tax refund and borrow money from yourself interest-free.
Other than these two programs, RRSPs are inflexible. If you withdraw funds for any other reason, you’ll have to declare it as income and pay withholding fees and taxes. You also lose that contribution room forever.
TFSA Non-Retirement Uses
Your TFSA, on the other hand, is the epitome of flexible. Contribute funds at any time and withdraw at any time with no penalties. The only restriction is that you don’t get back unused contribution room until the next year, and you’ll be penalized if you over-contribute.
For example, let’s say you have a TFSA with $20,000 in it. Your unused contribution room is $3,000. If you withdraw $5,000 from this account, you’ll get that $5,000 back in contribution room, but not until next year. So, if you plan to repay that $5,000, don’t do it until the next calendar year.
There are almost no barriers or penalties for withdrawing money from your TFSA, which could make it a poor retirement savings vehicle because you may be tempted to raid your account for home renovations and vacations. An RRSP, on the other hands, levies hefty fees for early withdrawal, rendering your money essentially locked in.
Verdict: RRSPs can be used to save for three things: retirement, your first home, and continuing education. TFSAs are very flexible and great for retirement or short to medium term savings goals—but watch out for overcontribution penalties.
Final Verdict: Should You Put Your Savings in a TFSA or RRSP?
While there are a lot of factors to consider when choosing between a TFSA and RRSP, the important rule of thumb to remember is that if you are earning more now than you plan to in retirement, an RRSP is the better choice, tax-wise. If the opposite is true, consider putting your savings in a TFSA instead. Of course, there are many caveats to this rule of thumb, a few of which we outlined above.