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RRSPs or TFSAs: Which is the Right Investment Option for You?

February 17, 2022

It’s that time of year when taxes and investments are top of mind for many, what with the rapidly approaching March 2, 2022 being the deadline for contributing to an RRSP for the 2021 tax year. One of the most common questions that our financial planners get at this time of year is whether to contribute to a Tax-Free Savings Account (TFSA) or whether to contribute to a Registered Retirement Savings Plan (RRSP). There is not a simple, clear-cut response - the answer will vary based on several factors that are specific to each investors’ situation, which we have reviewed below.

The Basics of RRSPs

Nearly 6 million Canadians contributed to an RRSP in 2019, with a median contribution amount of $3,260. Originally introduced in 1957, RRSPs were conceptualized in order to encourage Canadians to set aside some of their income to help support their cash flow needs once they retire from the workforce. By contributing to an annual RRSP, individuals are able to deduct that contribution amount from their taxes and pay less in taxes in the process. While taxes will still be required to be paid when the RRSPs are used during retirement, the assumption is that the individual will be in a lower tax bracket at that point and will therefore pay less income tax.

18% of a taxpayers’ annual income (up to $27,830 in 2021) can be contributed to an RRSP. There are also tax strategies in place around income splitting and contributing to a spousal RRSP. RRSPs must be terminated before the contributor turns 71, and there are three ways to proceed:

  1. Withdraw the RRSP funds, and pay tax on the withdrawal amount
  2. Use the funds to purchase an annuity, in which the contributor then receives a fixed monthly payment for a predetermined amount of time
  3. Transfer the funds to a Registered Retirement Income Fund (RRIF) and draw from that fund as needed

The Basics of TFSAs

TFSAs hit the market in 2009. Money that is sitting in a TFSA can earn interest and can be invested and can be withdrawn at any time tax-free. Whereas RRSPs were structured with retirement savings in mind, TFSAs tend to be used for shorter term investing and saving.

From 2009 – 2012, the maximum annual contribution was $5,000. This increased to $5,500 in 2013 and 2014. This was then briefly raised to $10,000 in 2015 by the Conservative Party before being bumped back down to $5,500 when the Liberal party took federal power. In 2019 the maximum annual contribution was again increased, this time to $6,000, for a cumulative 2022 total of $81,500. As of 2018, 14 million Canadians held over 20 million TFSAs, with a total fair market value of almost $300 billion.

Factors for Consideration

Both RRSPs and TFSAs have a time and place. And in a perfect world, one would be maximized in both vehicles. But, given that we live in an imperfect world, it’s worth considering some of the factors to weigh when determining whether to park your limited savings in a TFSA or an RRSP.

How much you earn

What tax bracket do you fall under? If your annual income is under $49,020, you’ll pay 15% in income tax. This increases to 20.5% with an income between $49,021 - $98,040, to 26% when earning between $98,041 and $151,978, to 29% when earning between $151,979 and $216,511, and finally 33% for anything over $216,512. Someone making $50,000 a year will pay $10,250 in income tax, but if they can get their income under $49,020 by putting even $100 a month in an RRSP, they will only pay $7,320 in income tax. That’s easy math right there.

Do you have RRSP employer benefits?

If so, take full advantage. Typically those companies who have RRSP benefits will match their employee contributions, and the employee contributions are removed via payroll deduction, making for a seamless employee experience. Taking advantage of ‘free’ money to invest is never a bad idea!

If you are in fact saving for retirement, than RRSPs are the way to go. For shorter term saving needs, like a new home, travel, or a vehicle, a TFSA could help you get there faster. It should be noted that $35,000 of RRSP savings can also be withdrawn for buying a first home (as part of the Home Buyers Plan) provided it is replaced in 15 years. Likewise, the Lifelong Learning Plan allows for $20,000 of RRSP savings to be withdrawn for full-time education or training.

The single best way to determine how to proceed investment-wise, is by discussing your financial situation and goals with your financial planner through your CPA firm. They will consider the above-noted factors, and more, and will customize a financial road map that will get you to where you want to be. If you are in need of advice, please reach out and we’ll connect you accordingly.