A quick search will highlight lots of articles that debate whether it is beneficial to invest inside the Tax-Free Savings Account (TFSA) or use the Registered Retirement Savings Plan (RRSP) for retirement.
We’ll be blunt for today’s post: while it can “depend” we believe the TFSA wins over the RRSP for a few key reasons that every adult Canadian should know about.
Read on why the TFSA wins over the RRSP in this TFSA vs. RRSP debate as you plan ahead for new TFSA contribution room in 2023.
TFSA vs. RRSP 101
What is a TFSA anyhow?
Over the last decade (and more), the Tax-Free Savings Account (TFSA) has been very popular with Canadians – although there is always room to improve.
On that note, the Bank of Montreal (BMO) released a study that revealed some insights into Canadians’ knowledge and use of TFSAs, and certainly there are opportunities missed by some:
- “Cash is King: Cash is the most popular asset – the majority (56 percent) of Canadians have cash in their TFSA and 29 percent say cash makes up at least three-quarters of their holdings.
- Knowledge Gap: While 73 percent of Canadians consider themselves knowledgeable about TFSAs, only half (49 percent) of Canadians are aware that a TFSA account can hold both cash and at least one of the other investments.
- Holdings Growth: Despite the ongoing challenges from the pandemic, Canadians on average hold $34,917 in their TFSAs, a 13 percent increase from 2020.”
Despite some underutilization of the TFSA by some Canadians, we believe the TFSA is an outstanding investment account for retirement income planning and worse-case, a great spot to park money for upcoming major expenses.
We won’t get into all the detailed reasons why we love the TFSA. We have an entire post about that already:
The crash course on that post is this:
- Each year, you get an allotment of the TFSA contribution room.
- That means TFSA contributions (and investments made inside the account) can compound tax-free.
- Compounding inside the TFSA is critical because any gains you earn inside the account (whether that’s via interest, growth, dividends, other) is not subject to capital gains tax, so you won’t owe any tax on your earnings when you make a withdrawal.
What is the RRSP?
A Registered Retirement Savings Plan (RRSP) allows you to invest up to 18% per year of your gross income, or up to an annual threshold value —whichever is less—without paying income tax on that money. (So, meaning, when you invest inside the RRSP with after-tax dollars, the tax will be refunded after you file your income tax return for that contribution year.)
The best way to think about an RRSP is a tax-deferred account.
Ideally, because you contribute to the RRSP while working (at a higher income level?) and because you might withdraw from the RRSP in lower-income years (in retirement?), you should pay less tax overall. Some might even consider the RRSP a form of tax arbitrage: the process of using the differences in how transactions and/or how accounts are treated for tax purposes to reduce the burden of taxation.
Read on about RRSP benefits and some drawbacks in:
A new year means new TFSA contribution room!
The TFSA contribution limit for 2023 has been officially released.
That limit is $6,500, up from $6,000, which was the amount set from 2019 to 2022.
In November 2022, the total available contribution room in 2023 (for someone who has never contributed and has been eligible for the TFSA since its introduction in 2009) is $88,000.
That’s a LOT of tax-free compounding power.
A reminder the annual TFSA dollar limit is indexed to inflation, but rounded to the nearest $500. The Canada Revenue Agency’s indexation increase for 2023 is 6.3%, up from 2.4% in 2022.
Here is another reminder for investors who might have made withdrawals from their TFSAs since 2009.
The formula is:
Unused TFSA contribution room to date + total withdrawal made in this year + next year’s TFSA dollar limit = TFSA contribution room at the beginning of next year
TFSA vs. RRSP. Why the TFSA wins over the RRSP in this TFSA vs. RRSP debate.
We’ll preface our opinions on this subject by saying the “best” investment vehicle for retirement or saving for any major purchase, is going to depend on your individual personal financial situation.
One size never fits all equally.
That said, we have a few things for you to consider why the TFSA “wins” over the RRSP.
Win #1 – The TFSA wins regardless of your income
You’ll find countless articles that suggest if your income is over $50,000 or $60,000 per year, that you might be better off investing inside the RRSP over the TFSA.
We would ignore that advice.
Sure, your income determines your taxation but the TFSA is a gift to every adult Canadian. It doesn’t matter if you make $25,000 per year, $50,000 per year or over $100,000 per year – by using the TFSA you can grow your investments tax-free and withdraw money tax-free.
The same is not true of the RRSP.
The RRSP tends to only benefit higher-income earners since as referenced above, any RRSP-generated tax deduction does not create huge benefits for lower-income earners. For those who make less than $50,000 or $60,000 per year, the RRSP-generated tax refund is simply less valuable, because after claiming basic tax credits, you aren’t likely to owe much income tax.
For any income earner, putting as much money into your TFSA has always made sense to us.
Win #2 – The TFSA wins regardless of your investing timeline
You’ll also learn on our site, that while the RRSP is great for multi-decade retirement saving and investing, it does need to be shut down eventually.
In the year you turn age 71, you must consider converting your RRSP to an RRIF (Registered Retirement Income Fund) by December 31 in the year you turn age 71.
This means the RRSP account essentially has an expiry date. Now, you don’t HAVE to convert your RRSP to an RRIF but we do think it’s one of the best options out there.
Conversely, there is no expiry date to the TFSA. It doesn’t have to be converted to another account. You don’t have to shift assets out of the account unless you want to. TFSA withdrawals don’t have tax consequences or withhold taxes as RRSP withdrawals do. That doesn’t matter if you make withdrawals in your 30s and 40s to buy a house or in your 80s and 90s to pay for longer-term care.
For these reasons and more, it is one of the key reasons to keep this account intact “until the end” when it comes to RRSP and TFSA withdrawal strategies.
My Own Advisor has an epic post about his plans – how and when to withdraw from your RRSP and TFSA – that we strongly encourage you to check out to be tax-efficient in your retirement drawdown order.
Win #3 – The TFSA wins when it comes to paying it forward
As you know from our site, we are huge advocates of managing your cash flow – meaning – you need to know where your money is going and when.
Although various programs exist for otherwise, essentially your RRSP money is earmarked for your retirement. The RRSP structure was designed so that when you withdraw the money from your RRSP/RRIF, you should be earning less, therefore in a lower tax bracket as we have discussed and therefore, hopefully, paying fewer taxes overall. Unfortunately, for all singles and couples – life happens – people pass away sometimes very unexpectedly.
Everyone must therefore realize that because life happens, the TFSA is better suited for anything that could or will happen. Because TFSA money can grow and be withdrawn tax-free, this makes the TFSA an outstanding estate planning account – your TFSA and your partner’s TFSA should be strongly considered to keep “until the end” when it comes to portfolio drawdown considerations.
In our work with clients, this is a common subject and these considerations come up often. Investors should consider drawing down RRSP/RRIF assets and/or non-registered assets before any TFSA assets are tapped.
For estate planning purposes, we’ve worked with clients to highlight a couple of key options for folks to consider when it comes to getting the most out of the TFSA in retirement:
- Consider naming a TFSA beneficiary – whereby the surviving spouse as an example could pay taxes on any interest or growth earned in the TFSA after their spouse’s death OR better still….
- Strongly consider naming a TFSA successor holder.
A beneficiary would get all of the money in your TFSA, and get it tax-free, and after that, the account would be closed. A TFSA successor holder gets the account and the money.
The estate planning isn’t as rosy for RRSP/RRIF account holders at the time of death.
For example, if you have no living spouse or partner to leave your RRSP assets to our CRA will add the fair market value of the assets held in your RRSP to your income in the year of your death.
This means keeping your RRSP/RRIF assets around for an extended period right up until death can trigger a significant tax bill for your estate that could diminish its value for your heirs, future generations, charities or other ends of life wishes. RRSP (and RRIF) beneficiaries is a complex and personal subject to tackle, and My Own Advisor has this covered below, something we’ll tackle in time on our site in response to our client needs.
Further Reading: Beneficiaries for TFSAs, RRSPs, RRIFs and other key accounts.
TFSA vs. RRSP – Why the TFSA wins summary
- Every adult Canadian should take advantage of the TFSA. This is why the TFSA wins over the RRSP in this TFSA vs. RRSP debate.
- Many adult Canadians should take advantage of the RRSP where it makes sense based on earned income in their working years.
- Please avoid these 5 big TFSA mistakes.
- Please avoid these 5 big RRSP mistakes.
If you follow these tips, we anticipate you’ll be wealthier for it.
Only in a few cases will the RRSP actually beat out the TFSA for a long-term investment account for most Canadians. If you want to really know when that applies make sure you read on here:
Improve your retirement readiness at a low cost!
Everyone has a different path on their asset accumulation journey. We know. At Cashflows & Portfolios, even though we both own 7-figure investment portfolios now, we’ve built our respective portfolios similarly but differently. The common denominator on our retirement readiness path is we absolutely max out contributions to our TFSAs and optimize the use of our RRSPs.
Whether it’s a better understanding of retirement readiness OR navigating the alphabet soup of RRSPs/RRIFs, LIRAs/LIFs, CPP, OAS and more – I know we can help you out.
We answer client questions such as:
- What registered accounts do I draw down first?
- How much income will my investments generate?
- Do I have any idea how long this income might last?
- What amount of taxes will my portfolio incur?
- When should I take my workplace pension?
- And much, much more…
Knowing how to demystify the retirement income puzzle is not trivial work but it’s absolutely something we can help with – we’ve helped dozens of clients in the last few months alone!
If you are interested in obtaining private retirement projections for your financial scenario, please contact us here to get started.
Stay tuned for more, great, FREE content on our site. We’re happy to help.
Mark and Joe.