RRSP vs TFSA: Which Is Right for Your Retirement Plan?

TFSA or RRSP?

Okay, it’s February and the same question pops up every year at this time. Do I put extra money into an RRSP or a TFSA????? Before making that decision let’s begin by seeing how these plans work.

Canadian Registered Investments

In Canada we have two common registered investments, the Registered Retirement Savings Plan (RRSP) and the Tax Free Savings Account (TFSA). They’re administered by the government and have rules attached to them; that’s why they’re called registered plans. These rules determine the yearly amount you can contribute to the plans, how taxes are treated, and the age limits for participating in them.

For example, the yearly limit for an RRSP contribution is 18% of your previous years gross income to a maximum of $29,210 (for 2022). The yearly limit for a TFSA contribution was $6,000 for 2021, has increased to $6,500 for 2022, and $7,000 for 2023. These limits change yearly as set by the government. Okay, so that’s the two plans; how do I decide which one to put my hard earned savings into?????

So Where Do I Put My Money?

One of the most discussed and confusing topics these days is the question of whether to invest in an RRSP or TFSA. There is both an easy and complicated answer to this question. The easiest solution is to contribute the maximum amount to both plans.

After all, tax sheltering opportunities are few and far between in Canada. Assuming for 2022 you qualify for the maximum RRSP amount ($29,210), plus the TFSA limit ($6,500) you could invest $35,710. Even with a lower RRSP limit, most people simply don’t have that much money to invest. This situation requires a more complicated answer.

I lean toward investing in an RRSP first and a TFSA second for two reasons. Firstly, most people will have a lower income in retirement. An RRSP allows you to defer taxes while you are working, and then pay less tax when you cash out that money in retirement. Secondly, RRSP’s have more leverage than a TFSA. When you invest in an RRSP, even if it’s below your maximum amount, you reduce your taxable income which sets you up for a tax refund.

Get a Tax Refund for Investing in Yourself

If you reinvest that tax refund into next year’s RRSP, plus make the same regular contributions (or increase them if you get a raise in salary), you increase the amount invested year after year. This strategy will ensure increased RRSP contributions when repeated yearly. Remember, for every dollar you invest in an RRSP you get a tax refund of a fraction of a dollar to reinvest. The fraction of a dollar is based on your tax rate which naturally increases with income.

That extra amount is your leverage, which allows you to grow money faster in an RRSP. Yes, you’ll still have to pay tax on that money eventually when you retire (predicted to be at a lower tax rate). But contributing more money early means your money can grow and compound faster over time. Simply put, leverage equals free money.

A TFSA simply doesn’t have that leverage; a dollar invested is a dollar invested, with no reduction to your taxable income or potential tax refund. Actually, it’s an after tax dollar, making it even more difficult to increase your invested amount. Most people still don’t realize that a TFSA contribution does not result in a tax refund. Regardless of your income, if you can max out your RRSP, by all means put any excess into a TFSA.

Getting a Late Start for Your Retirement

If you’re starting to save for retirement later in life and have no company pension plan to rely on, a good strategy is to aim for maximizing your RRSP and TFSA investments every year. And that also means catching up on any carry forward amounts these investments have. These two registered investments are your best opportunity to ensure a comfortable retirement.

My Story

Skeptical? At age forty five, with virtually no savings and starting from scratch, I maximized these two registered plans yearly. I now have a comfortable retirement that started at age sixty.

Have you ever wondered why the RRSP question comes up every February? Since it’s human nature to procrastinate we commonly face this issue in February as the RRSP contribution deadline approaches. We can thank financial institutions for reminding us. Heck, they even have a name for it: “RRSP season”. The cost of procrastinating is having to make a one-time yearly contribution in February which most people simply can’t afford.

Should I Borrow to Invest in My Retirement?

The banks understand our procrastination and we’re bombarded with commercials to push RRSP contribution loans. That’s the topic for another day but in general borrowing money to invest in your retirement is a bad idea. The best strategy is to make fixed monthly contributions throughout the year so you don’t face a guilt ridden decision every February.

Why invest in these plans? To be blunt, we are a nation that is taxed excessively. These plans allow you to delay paying taxes and then pay them later at a lower rate (RRSP), or shelter a limited amount from taxes forever (TFSA). You’d be crazy not to use these tax havens.

In my E-books (“Water Barrel” and “The Balance”) I discuss simple methods to live sensibly for today, take charge of your financial affairs, and invest safely for the long term. For more information please visit David Penna Amazon.

As always, I am not a qualified financial advisor. I just relate financial management to my own experience which may not resemble yours at all. Advice is frequently worth exactly what you paid for it. Most of mine came from expensive experiences.