When the RRSP actually beats the TFSA

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In a recent post, we told you many reasons why the TFSA “wins” over the RRSP.

Well, there are some cases in our opinion when the RRSP actually beats the TFSA as an investment account.

Read on why the RRSP actually beats the TFSA for a few reasons in this updated edition of the TFSA vs. RRSP debate.

The TFSA wins over the RRSP for three key reasons

Despite some underutilization of the TFSA by some Canadians, we believe the TFSA is an outstanding investment account for retirement 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 in this post today – we’ve covered that already in great detail here: Everything you need to know about the TFSA.

The crash course on that post above is:

  • 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.

Even though the current annual TFSA contribution limit ($6,000 per adult) remains lower for most income earners (when compared to the RRSP contribution room), we believe the TFSA “wins” over the RRSP for these three reasons:

  1. The TFSA is a gift of an account for every adult Canadian – regardless of their income level.
  2. The TFSA has no expiry date.
  3. The TFSA is almost a perfect estate planning tool to transfer wealth (we often see this in the retirement projections that we do for our clients).

Read on in far more detail in this post: Why the TFSA wins over the RRSP.

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.

To use this tax-deferred account to your full advantage, you must reinvest the RRSP-generated tax refund every, single, year.

My Own Advisor calls this the linchpin in an RRSP vs. TFSA debate.

Assuming you always reinvest the RRSP-generated refund back into the TFSA, we believe there might be reasons to make the RRSP your go-to investment account for retirement planning – with some other caveats of course!

To use this tax-deferred account to your full advantage, you must reinvest the RRSP-generated tax refund every, single, year.

When the RRSP actually beats the TFSA

Reason #1 – You have RRSP matching with your employer

Free money as an employee benefit?

We say, go for it.

With defined benefit pension plans disappearing like the dinosaur has, your employer might offer a group Registered Retirement Savings Plan to you. Group RRSPs are very likely to differ from employer to employer, so it is important to understand the plan offered to you.

Generally, group RRSPs are provided by our major insurance companies like Sun Life, Manulife and Great-West Life—these are the top three group RRSP when you look at the number of assets (contributions) they are managing. This is not a bad thing, but some reminders and caveats.

On the positive, group RRSPs offer an employer matching contribution. For example, if you contribute to the group plan, your employer may kick in a certain percentage of your salary, say 5% or so which could be equal to or higher than your contribution, in some cases. Your contributions plus your employer’s contributions to the group RRSP cannot exceed your available RRSP room as reported on your notice of assessment for the previous year.

The downside is some group RRSP investment options are limited to (more costly) mutual funds instead of indexed funds – although that’s slowly changing.  A reminder to please pay attention to any fund management expense ratio (MER) since fees are forever – as in you never get that money back to help your compounding power.

Given the benefit of free employer money as a workplace benefit to accelerate your RRSP contributions for retirement planning, essentially contributing any RRSP contribution before you have any chance to spend the money as in your personal life, then group RRSPs can be an excellent way to juice and automate your savings for retirement.

Reason #2 – You want to take advantage of a Spousal RRSP

Not all couples or partners work full-time nor have high-paying jobs, to say the least.  Every family’s needs and dynamics are different – so best know when a spousal RRSP makes sense.

We believe spousal RRSPs can help lighten the tax load for some couples — both now and in retirement.

Open to both married and common-law couples, a spousal RRSP is a retirement vehicle that allows the higher-earning spouse to make contributions to an RRSP account in their partner’s name — and benefit from the tax deduction.

Spousal RRSPs work best when there is a large, long-term income disparity between partners. If you’re the spouse with the higher income, you’ll use up some of your contribution room to invest in the spousal RRSP, but in retirement, your spouse is the one who withdraws from it. The result?

Less tax owing overall.

When looking ahead, in retirement, the main advantage of a spousal RRSP is that it allows a couple to split their RRSP income.

Even without a spousal RRSP, couples can split up to 50% of eligible pension income. This can include withdrawals from a registered retirement income fund (RRIF) or income from a registered company pension plan.

However, with some advance planning, a spousal RRSP could let you move more than 50% of your pension income to your spouse, something that might be useful if you have other sources of income when you retire to be tax-savvy.

A reminder and some more caveats: spousal RRSPs are meant for long-term retirement savings. If money is withdrawn within three years of a contribution, the funds will be taxed as your income — not your spouse’s (this is called the three-year attribution rule). For example, if your most recent contribution to a spousal RRSP was 2020, your spouse should wait until 2023 to make any withdrawals. Otherwise, the withdrawal will be added to your income — and your tax bill.

Although various programs exist for otherwise, essentially your RRSP money is earmarked for your retirement. Yet with some careful tax planning, a spousal RRSP can be an excellent structure to ensure you and your spouse pay less taxes in retirement.

Reason #3 – Taxes in retirement will be lower?

As you know from our site, touting the praises of the TFSA – you know it doesn’t matter if you make $25,000 per year, $50,000 per year or over $200,000 per year – by using the TFSA you can grow your investments tax-free and withdraw money tax-free.

The same is simply 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.

If however you have already maxed out your TFSA of contribution room (and you should try to, every single year…) then naturally invest in your RRSP before taxable investing.

Further still, if you know for sure your tax rate in retirement is going to be lower than your asset accumulation/working years, then yes, by all means, try and max out that RRSP.

Here are some rules of thumb related to this debate:

  1. If your marginal tax rate at the time of contribution is greater than your marginal tax rate at the time of withdrawal/retirement, then definitely consider contributions to your RRSP.
  2. If you have a group RRSP available to you, take the free money and yes, contribute to your RRSP.
  3. If you don’t have a group RRSP at work, and you remain unsure how to invest, we suggest you max out the TFSA first and if any money is leftover, make contributions to your RRSP.
  4. If you have a high, sustainted income AND your spouse/partner does not work, then consider creating a spousal RRSP to support any future income splitting for retirement planning.
  5. If you can, contribute to both!

When the RRSP actually beats the TFSA summary

For the most part, we’re fans of the following contribution order for asset accumulation for pretty much every Canadian for investing flexibility:

  1. Contribute to your TFSA first, max it out, and keep doing so for decades.
  2. If #1 is done, contribute to your RRSP or create a spousal RRSP if that makes sense.
  3. If #2 is done, then consider investing in a taxable account.

For any income earner, putting as much money into your TFSA and then into your RRSP, has always made sense to us although in some cases, the RRSP might make better sense.

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.

Need support?

Whether it’s a better understanding of retirement readiness for your RRSP, TFSA, or navigating the alphabet soup of RRSPs/RRIFs, LIRAs/LIFs, CPP, OAS and more for retirement drawdown – 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.

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2 thoughts on “When the RRSP actually beats the TFSA”

  1. Reason #4 is that if you are just not going to have enough income in retirement that it would bump your net income in to a higher bracket. If somehow you can still max out your TFSA it would be the best of both worlds.
    Obviously this would take some forward projections on your future income until retirement and some conjecture as to the RRSP portfolio value at retirement. No small task.

    RICARDO

    Reply

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