Should I contribute to my TFSA or RRSP? This is a common question when it comes to saving for retirement. It isn’t always financially possible to maximize the annual contribution to both, so many people often need to prioritize and invest in the registered savings account that makes the most sense for them.
In order to determine which option makes the most sense for you, it’s important to first understand the differences between them.
The differences between RRSP and TFSA accounts
| RRSP | TFSA | |
| Funding contributions* | RRSP contributions are made with pre-tax dollars | TFSA contributions are made with after-tax dollars |
| Deductibility of contributions | Contributions are tax deductible in the year they are made – or can be carried forward to another tax year | Contributions are not tax deductible |
| Contribution limits | Contribution limit is based on your earned income from the prior tax year – up to an annual maximum. Contribution room can be carried forward | Contribution limit is predetermined each year. Contribution room can be carried forward
|
| Investment income | Investments grow tax-free | Investments grow tax-free |
| Withdrawals | Withdrawals are taxed. No impact on contribution room | Withdrawals are tax-free. Contribution room equal to the withdrawal is added back the following calendar year |
| Age limits | Contributions can be made up to December 31 of the year you turn 71 | No age limit |
*Note: you need earned income (salary, self-employment income, etc.) to contribute to an RRSP. If you are an owner-manager of a corporation and remunerate yourself exclusively with dividends, you will not generate RRSP contribution room.
A primary difference between these two accounts is the timing of taxation:
- An RRSP provides a tax deferral. This is advantageous if your marginal tax rate will be lower in retirement.
- TFSAs permit tax-free growth of your investments. This option is most advantageous if your marginal tax rate will be higher when you withdraw the money.
- If you expect your marginal tax rate to be the same at the time of contribution and withdrawal, then both options will yield a similar result.
Here is a simplified scenario to demonstrate this:
Higher Tax Rate at Contribution
| RRSP | TFSA | |
| Pre-tax income | $1,000 | $1,000 |
| Tax (53%) | NA | 530 |
| Net contribution | 1,000 | 470 |
| Value in 20 years (6% per annum) | 3,207 | 1,507 |
| Tax on withdrawal (40%) | 1,283 | NA |
| Net withdrawal | 1,924 | 1,507 |
Higher Tax Rate at Withdrawal
| RRSP | TFSA | |
| Pre-tax income | $1,000 | $1,000 |
| Tax (53%) | NA | 400 |
| Net contribution | 1,000 | 600 |
| Value in 20 years (6% per annum) | 3,207 | 1,924 |
| Tax on withdrawal (40%) | 1,700 | NA |
| Net withdrawal | 1,507 | 1,924 |
Same Tax Rate at Contribution and Withdrawal
| RRSP | TFSA | |
| Pre-tax income | $1,000 | $1,000 |
| Tax (53%) | NA | 400 |
| Net contribution | 1,000 | 600 |
| Value in 20 years (6% per annum) | 3,207 | 1,924 |
| Tax on withdrawal (40%) | 1,283 | NA |
| Net withdrawal | 1,924 | 1,924 |
Taxpayers generally earn a lower income in retirement, so one would expect most people to fit within the first scenario. In any event, the timing of taxation is an important thing to consider when you are evaluating whether to invest in an RRSP or TFSA.
March 1, 2019 is the deadline for contributing to an RRSP for the 2018 taxation year. The tax professionals at S+C Partners would be happy to help you review your options and prepare for the upcoming tax season.