How To Make The TFSA vs RRSP Decision Like A Financial Planner

Owen Winkelmolen

Fee-for-service financial planner and founder of PlanEasy.ca

It’s getting to be that time of year again. Time for taxes, time for RRSP contributions, and time to debate whether a TFSA contribution or an RRSP contribution is the best choice.

RRSP season naturally creates this question for many people. Is an RRSP contribution really the right choice? Or would a TFSA contribution be better?

Unless you’re fortunate enough to be maxing out both accounts, the TFSA vs RRSP decision has been an annual conundrum since the introduction of the TFSA in 2009. If you’re not well versed in the differences between the TFSA and the RRSP, read this intro to the TFSA and this intro to the RRSP to get a better sense of the differences.

The TFSA and the RRSP two of the main tax advantaged retirement accounts in Canada. You can use one, the other, or both to save for retirement.

Using the TFSA alone can be enough for a luxurious retirement, one that is 100% free of taxes. However, in certain situations, the RRSP can provide A HUGE benefit by lowering your lifetime tax bill.

Which one you use depends on your situation, and not just your situation now, but also your situation in retirement. To make the decision even more complex there are also some soft benefits that can help push you toward the TFSA or the RRSP when all the other factors are equal.

Deciding between the TFSA or the RRSP can be tough. Making the right decision could be worth $10,000’s to $100,000’s. If you feel like you need help then please reach out to us. We help clients optimize their taxes and benefits, and choosing between the TFSA and the RRSP is an important consideration. A financial plan from a fee-for-service planner can easily save you thousands of dollars and also make these tough financial decisions much easier.

This TFSA vs RRSP guide takes a financial planner’s perspective on the decision between a TFSA and RRSP. Learn how to make the TFSA vs RRSP decision just like a financial planner would. Look at all aspects of the decision, not just taxes, not just government benefits, but everything.

Here’s how to make the TFSA vs RRSP decision like a financial planner. Each factor is important, but the weight you give each one depends on your own situation and goals.

 

 

What is your current marginal income tax rate?

Your marginal tax rate is the percentage of tax you pay on the next dollar of income. If you’re in the top tax brackets this can easily be in the 40-50% range. The higher your current marginal income tax rate is the more attractive an RRSP contribution becomes. Individuals in the highest marginal tax brackets will likely want to prioritize the RRSP, and individuals in lower tax rates will likely want to prioritize the TFSA, but there are other factors to consider.

 

 

What is your income tax rate in retirement?

Eventually those RRSP contributions needs to be withdrawn, so it’s important to also understand your marginal tax rate in retirement. It can get slightly more complicated because during retirement you might be making RRSP withdrawals that cross over a couple of tax brackets. In this case, you want to understand the average tax rate on withdrawal. Anyone who has a higher tax rate in retirement than when they’re making contributions will probably want to prioritize the TFSA, but income taxes aren’t the only factor.

 

 

What is your current government benefit claw back rate?

Many government benefits are income tested. They’re based on your net income, line 236 of your tax return. RRSP contributions will lower your net income and will lead to higher benefits. How much higher? Families with children can see benefit increases as high as 20-30% of their RRSP contributions. So not only will an RRSP contribution create a income tax refund, but it can boost their benefits as well. Benefit claw back rates act like tax rates, and when making the TFSA vs RRSP decision they should be considered the same way income tax rates are.

 

 

What is your government benefit claw back rate in retirement?

This is a very important factor that many people don’t consider (and it’s hard to blame them). To make a good TFSA vs RRSP decision you need to understand what government benefits you’ll be eligible for in retirement. Some government benefits like OAS and GIS come with claw back rates. RRSP withdrawals can lead to smaller benefits. They act the same way as a tax rate and should be considered similarly. OAS claw backs are 15% of the next dollar of income. GIS claw backs are even worse, between 50-75% of the next dollar of income. If you’re eligible for GIS in retirement (and about 1/3rd of seniors are) then you could be losing 50-75% of your RRSP withdrawals to claw backs! In this case you absolutely want to prioritize the TFSA which doesn’t impact government benefits in retirement.

 

 

Would you benefit from sharing contribution room?

With the RRSP there are very strict rules. Contributions need to come from your own earned income. If you give your spouse money to make an RRSP contributions the CRA will have some nasty things to say about it. But TFSAs on the other hand are way more flexible. You can give your spouse money and they can use that money to make a TFSA contributions without any issue. This effectively lets you share contribution room with a TFSA and could be an advantage in certain situations.

 

 

Do you need creditor protection?

Some people may not realize this, but TFSA contributions have no protection from creditors, but RRSP contributions do! After a certain period of time creditors cannot touch money you have inside an RRSP. This is not the case for a TFSA. If the unfortunate were to happen and creditors are forcing you to liquidate your assets then your RRSP is safe whereas your TFSA is not.

 

 

Could you benefit from contribution room in the future?

One of the under appreciated benefits of a TFSA is that contribution room comes back. When you make a TFSA withdrawal that amount gets added to your new contribution room for the following year. This can be a huge benefit in retirement. If you’re using your TFSA for retirement it will probably grow quite large from compounding. As you draw down your TFSA to create retirement income it will create more contribution room the following year. That contribution room will just continue to build as you make withdrawals. If you suddenly come into a lot of money, maybe from downsizing your primary residence or perhaps from an inheritance, then you’ll have a large amount of TFSA contribution room to shelter the proceeds. This isn’t the case with RRSPs, as you use contribution room it disappears forever and never comes back. The flexibility of a TFSA gives it a slight advantage for future tax planning scenarios.

 

 

Do you typically spend your tax refund?

If you’re in the habit of spending your tax refund, maybe on a vacation or just on something nice, then an RRSP might be a bad choice. When you’re making RRSP contributions with after-tax dollars (money you got from your paycheck after tax has already been paid) only way an RRSP will help is if you save your tax refund and contribute it to your RRSP next year. When you make an RRSP contribution with after tax dollars the extra tax refund you create isn’t actually yours, it’s actually taxes that you’ll owe in the future when you make RRSP withdrawals. If you spend this tax refund now, then you’ll have nothing to pay your future tax bill, and you’ll have to take more out of your RRSP to compensate. If you’re in the habit of spending your tax refund then the TFSA is a better choice.

 

 

Would you appreciate more or less flexibility?

This is a benefit that can go in either direction. RRSPs are less flexible, they don’t let you take out money very easily. RRSP withdrawals will trigger taxes and you’ll never get that contribution room back. This can be a big barrier for people considering an RRSP withdrawal. TFSAs on the other hand are extremely flexible. Withdrawals can be made at any time and the contribution room comes back next year. If you feel like you might be tempted to raid your retirement savings then having that extra barrier between you an your money can make an RRSP more appealing. On the flip side, if you feel like you have good control, and would benefit from the flexibility, then perhaps the TFSA is more appealing.

 

 

Will mandatory withdrawals be a problem?

Once you reach a certain age your RRSP morphs into something else. By the end of the calendar year that you turn 71 you’re required to change your RRSP into an RRIF. The unfortunate thing about RRIFs is that there are mandatory minimum withdrawals. Each year you MUST withdraw a certain % of your portfolio. This can reduce your flexibility in retirement, it might create income you don’t need and trigger taxes you didn’t want to pay. With a TFSA there are no minimum withdrawals so contributions can continue to grow, and grow, and grow, until you decide to take them out. In some situations, this can make the TFSA more appealing.

Owen Winkelmolen

Financial planner, personal finance geek and founder of PlanEasy.

New blog posts weekly!

Tax planning, benefit optimization, budgeting, family planning, retirement planning and more...

New blog posts weekly!

Tax planning, benefit optimization, budgeting, family planning, retirement planning and more...

2 Comments

  1. Caroline at Costa Rica FIRE

    I live in the US so our retirement accounts go by different names but the tradeoffs are similar. During my full-time working years, I was in such a high tax bracket with little other deductions that it made sense to go for any plan that allowed some tax shelter. My husband did the same. What’s been hard is that we are way over-indexed on tax-deferred retirement accounts and too young to pull these out without penalty. I don’t regret doing it the way we did — we made the best decision for our situation at the time — and it’s a happy problem that we have a chance to live a FIRE lifestyle now and just need to figure out the tax issues. But it does make me think differently about how to advise my daughter, who just graduated college and started a new job. For all the reasons you cited, it’s not so cut and dry, what the best retirement account is — it really is an individual decision

    Reply
    • Owen

      That’s too bad that there are penalties for withdrawals before a certain age!

      Reply

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