TFSA Vs. RRSP – Which Account Is Best For Your Retirement Funds?

by Mike Holman

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This question of TFSA or RRSP for your retirement funds is a tough one, because there are a lot of variables to consider.  To make things worse, some of these variables are unknown, which means you have to make assumptions about future events which might not be all that accurate.

I’ve put together some very general guidelines which might help guide the decision of where to put your retirement money.  My suggestions are very generic – it is important to understand the reasoning behind the suggestions and to be able to apply it to your situation or consult an investment or tax professional.  The further you are from retirement – the greater the uncertainties.

Quick review – Contributions to an RRSP are “pre-tax” and result in taxable income on withdrawal.  Contributions to a TFSA are “after-tax” and do not have any taxable implications on withdrawal.

RRSP contributions work great if you are withdrawing at a similar or lower marginal tax rate compared to the contribution.  If you are withdrawing at a higher tax rate or if you will be receiving GIS payments, the RRSP is probably not a good choice.

Here are some suggestions to help decide whether to contribute to an RRSP or a TFSA.  The income numbers refer to your current working income.

These income ranges were taken from the Ontario marginal tax rate page at TaxTips.ca.

High working income – $75,000 or more

In this case, the RRSP is likely to be the winner or equal to the TFSA.  If you are contributing at a high marginal tax rate, it’s likely that you will be withdrawing at a similar tax rate or lower in retirement.  The OAS clawback could influence this equation, but that doesn’t affect many people.

Michael James expands on this idea in Downside protection of the RRSP.

Low working income – Less than $38,000

In this scenario, the TFSA is likely to beat an RRSP or at least tie.  The reasons for this are:

  1. You are contributing to the RRSP at a low marginal tax rate.  There is a good chance that your marginal tax rate will be similar or higher in retirement.
  2. GIS clawback.  If your income is low enough to qualify for GIS – the TFSA will be a clear winner since withdrawals do not count as income.  If you are likely to qualify for GIS payments, contributions to RRSPs should be avoided altogether.

Medium working income – $38,000 to $75,000

This range is a grey area, since neither RRSP or TFSA is a clear winner.  In this case, splitting your contributions money between the TFSA and RRSP is a good strategy.  Or if in doubt, focus on the TFSA, since you can always use that money to contribute to an RRSP later on.  Take a look at your marginal tax rates and try to decide yourself what to do.

Some more TFSA vs RRSP factors to think about if you really want to get complicated

Tax rates can change

  • The various tax brackets and marginal tax rates could change before you get to retirement.

OAS clawback

  • Currently OAS payments get phased out if your net income is above $67,688 (for the 2011 tax year).  The clawback is 15% of the net income over that number.  Once your net income reaches $109,607, the OAS payment will be zero.
  • Withdrawals from your RRSP or RRIF will be added to your net income.  TFSA withdrawals will not.
  • The OAS clawback acts like an extra tax on your marginal rate.  If a retiree makes an extra thousand dollars, they will lose 15% due to the OAS clawback.
  • Age credits – Once you hit 65, some credits become available which can lower your net income.
  • Income splitting – It is very easy for married or common-law seniors to split their retirement income with a spouse for tax purposes.  This will likely lower their net income.
  • If you are not sure about whether the OAS clawback will affect you – consider that only about 5% of seniors currently have their OAS payments clawed back or eliminated.
  • If you can split income with a spouse, you would need to have a minimum gross income of roughly $140,000 in today’s dollars before you would even start to have any OAS clawed back.

RRSP contributions can span different tax brackets

  • I’ve estimated that if you make more than $75,000, the RRSP is likely a good choice.  But what if you make $76,000 and contribute $5,000?  In that case, only $1,000 of your contribution is at the higher level.  The other $4,000 is in the “grey” area.

You can control RRSP/RRIF withdrawals and retirement date

  • If you are 50 years old, have a two million dollar RRSP and are starting to worry about having “too much” money – consider retiring earlier.  Or start contributing to a non-registered account, once your TFSA is maxed out.

TFSA contribution room limited

  • If you make more than $28,000 per year – you will have more RRSP contribution room each year than TFSA room.  Plus, most people have lots of unused RRSP room.  If you make a decent income and can save a lot of money – you will quickly use up your TFSA room.

You have other options

  • If you are at a point where you have maxed out the TFSA and don’t want to contribute anymore to an RRSP – you can put the money into a non-registered account.

Canadian dividend gross-up

  • Dividends from Canadian companies get a preferential tax treatment.  However, they also result in increasing your net income by the amount of the gross-up, which can decrease OAS payments.

Tax-free savings account have no withdrawal restrictions

  • One of the dangers of the TFSA is that you can do a withdrawal anytime for any amount without any kind of penalty.  RRSP withdrawals are subject to withholding taxes and are considered taxable income.  For some people, money in a TFSA might be too easy to access.

The future is uncertain

The younger you are, the harder it is to determine which account to put your retirement money.  When in doubt – contribute to the TFSA first – you can always withdraw from your TFSA and contribute to your RRSP later on.

Good articles on TFSA vs RRSP

The Advantages of RRSPs over TFSAs from Canadian Capitalist.

New debate between RRSP and TFSA from Retire Happy Blog (Jim Yih)

More information

TFSA rules

Rules for converting your RRSP to a RRIF


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{ 22 comments… read them below or add one }

1 Canadian Capitalist

Thanks for the mention Mike! I wouldn’t call TFSA contribution room limited. For an Ontario resident in the $50K bracket, the $5K (after-tax) TFSA room is the same as a $7,250 (pre-tax) RSP room. Granted that’s less than the $9K RSP room but if the taxpayer saves the maximum TFSA amount, they’d be much farther ahead than most other Canadians in the same income cohort.

2 Mike Holman

@Cdn Cap – Very true. What I meant is that compared to RRSP contribution room (which a lot of people have a lot of), the TFSA provides less opportunity for contributions.

3 Jim Yih

Thanks for the mention Mike! You have put together a very comprehensive list of issues. It’s really not black and white!
Cheers!
Jim

4 Echo

As a young Canadian I think the TFSA has tremendous potential for my retirement plan. I also like the idea of contributing to my TFSA even in retirement as an estate planning strategy.

You are right that it may be accessed too easily by some people, negating the long term benefits.

5 My Own Advisor

Great post Mike! I was thinking about writing something similar, but now I need to wait until next year to do it :)

Do you personally favour one over the other? I assume you’re using both accounts?

6 Money Smarts Blog

@Jim – Thanks. Yes, the issue is impossible to define perfectly.

@Echo – Sounds like a great idea. A young saver with a decent income should be able to max their TFSA and perhaps contribute $5k – $10k to their RRSP as well. I’m sure that would set them up pretty well for the future.

@My Own Advisor – Go ahead and write the article. I’m sure you will have some different ideas than I.

At the moment, I’m only using RRSPs for retirement. I’m in a high tax bracket and it’s a no brainer that I can’t go wrong with RRSPs. We use TFSAs for our emergency fund.

Things could change however – If I can use up all my RRSP room, then I’ll start using the TFSA for retirement savings. If I became a full-time author at some point, I’d definitely focus on TFSA more since my income would be crap. :)

7 Marie

Good post. This does help to further clear up some confusion for me over these two. I will book-mark and pass onto others. It’s good to see posts that are not gimmicky or too self-indulgent as with some more well known ‘experts’ and their acronyms, isms, and “I call it my…” phrases which are usually just a rehash on an old idea. Must be vent day.

8 Sustainable PF

Mike – where did you get the $75,000 salary number? I am aware of the 2011 $81k and change number where income tax increases but I am not familiar with the $75k marker. Can you elaborate on this?

9 Mike

@SPF click on the taxtips link for marginal rates in Ont.

10 Canadian Capitalist

Mike, that’s a good point. Yes, most folks likely have tons of RRSP room but limited TFSA room.

11 Marie

“If I became a full-time author at some point, I’d definitely focus on TFSA more since my income would be crap.”
@Mike: Been there done that over 15 yrs ago when my partner and I were both laid off due to ‘restructuring’ and chose to go it on our own. Let’s just say our living room was our office, we learned to like nachos and salsa for dinner and our first employee (a highly gifted programmer) learned to work in VERY small one bedroom unit/ office. The sacrifices were worth it but it can feel like jumping off a cliff and hoping your parachute opens! Life is short so I hope you choose to make the leap at some point. Hopefully you’ll be smarter than us with start up capital …although we DID lose some weight!

12 My Own Advisor

@Mike, I had to laugh at the full-time author comment.

13 Money Smarts Blog

@My Own Advisor – Good! It was supposed to be a joke. :)

@Marie – Thanks for the story – very interesting.

Very funny comment about the “I call it my…” thing that you often hear from self-promoting financial advisors or “experts”. :)

14 Marie

@CC: Yes, that’s my partner and I. We’ve actually been advised by our CA that it can be a good strategy for small biz owners, at certain times, have larger amounts of money being pulled from the company be paid out directly to an RRSP. Although, this article and your posts certainly have us considering TFSAs as part of our future investments as well.

Thx

15 Marie

@CC: Yes, that’s my partner and I. Our CA has suggested in the past that it can be a good (tax effecient) strategy for small biz owners, at certain times, when larger amounts of money are being (or can be) pulled from the company be paid out directly to an RRSP. Although, this article and your posts certainly have us considering TFSAs as part of our future investments as well.

Thx

16 Patrick

If your biggest problem is that you have a 2-million dollar RRSP filled with investments on which you have not yet paid a dime of tax…

17 Marie

@Patrick: Agreed and laughing. I think Cdn Cap. made a similar comment. But hey good for those who do. Some of us still play the lottery. At least those winnings (if you do) are still not taxed…yet.

18 Ronald R. Dodge, Jr.

Not really sure what the actual definition is of RRSP, but I’m assuming it’s “Pre-Tax Sheltered Accounts” or PTSA while you have the TFSA which I assume meaning “Tax Free Saving Accounts”, which I would think of as “After-Tax Sheltered Accounts” or ATSA.

I personally am in that gray area. As for which way to go, I do have money going both ways. However, the only reason why I have money going into PTSA is so as to take full advantage of the employer’s matching policy, though this matching policy is watered down by the higher annual mutual fund fees (stated as either 0.50% or 0.75%, but when performances compared against their respective market benchmarks, works out to be more like 2% management fees). As such, I do put in enough to max out the matching policy, but not a red cent more. After that, I then put in any more money for retirement savings into ATSA. Reason for this, given how well I been doing on our savings goals and objectives among other reasons, I expect our marginal tax rates to be significantly higher in retirement years than where they are now. Due to other financial objectives and goals that needs to be met, I have not put in enough to max out the ATSA, but once those other objectives are met, I will then be maxing out the ATSA before I will go about maxing out the PTSA.

I’m not sure how Canada’s stuff works, but in the USA, we have what’s known as provisional income limits on our SSA benefits. Given the fact those limits ($25,000 and $32,000 for Single and Married Couples respectively) has been static (meaning they aren’t adjusted as inflation takes place), by the time I retire, 85% of any SSA benefits we get under this rule will be considered as taxable income. Yes, there’s that $12,000 gray area beyond that initial $25,000 and $32,000, but think about it, can you really expect to live on $44,000 as a married couple per year? I don’t think so. In survival mode, yes, but to really live it out with a reasonable entertainment budget of what is suppose to be your so called golden years, I don’t think so. As such, you are essentially having to pay tax on this 2 times cause not only did you pay income tax on employee portion of the FICA taxes, but you also end up paying taxes on 85% of the FICA benefits, hence double taxation essentially.

In the USA, you can’t just withdraw from one and put into the other, but rather you can only do it via conversions. I don’t believe you can convert a ROTH IRA back into a Traditional IRA, but then that don’t seem to be a desireable option to many people either. I don’t see it stating you can’t do it, but I also don’t see anything stating how it would deal with the tax situation, so as such, I’m more or less assuming it’s not allowed. On the flip side, you can convert PTSA into ATSA, but then you also pay the taxes on that conversion too.

One limit though with IRAs as opposed to employer’s PTSA plans, you can only put in up to $5,000 (or $6,000 if 50 years of age or older by the end of the tax year) per person into all IRAs combined while it’s $16,500 (or $22,000 for those 50 or older by the end of the year) into employers retirement plans. Of course, there are other income limitations to these, so that has to be looked into even further, but these are the basic starting points.

As for government claw back rules, I could care less cause after what I been through in my college years (not to say anything about my childhood years that were in many respects horrible) and how the government welfare rules are setup, it’s almost like if you ask for help from the government, you must go by their rules and be under their control, so thank you, but no thank you. Not only that, but I don’t believe you can really have too much money in retirement accounts for various reasons. I would rather have $10,000,000 in retirement funds at the start of retirement with the government taking away my SSA benefits entirely, then to have less than $2,000 in total assets in order to get any sort of help from the government (Yep, that’s one of their welfare rules. They say countable assets, but with a family of 7, you can’t live on $2,000 too easily for 1 month unless you have no debt and no rent/mortgage).

19 Eclectic Investor

In general it’s a good article and as usual, I’ve learned something.

However, I have to point out that YMMV quite dramatically for the “you will have more RRSP contribution room each year than TFSA room”.

A defined benefit pension plan is going to cap and likely result in a much faster drop in available RRSP contribution room. I’ve got a co-worker who has already maxed out his RRSP. So for 2010, his RRSP contribution boils down to the 2009 earned RRSP contribution room – while the 2009 RRSP max room is $21K the pension adjustment is $15.8K for the db plan contributions of approximately $3K, so the 2010 RRSP contribution room is $5200 for his decent income.

Take your pick as to whether the TFSA $5000 or the RRSP $5200 is going to be gone faster.

A defined contribution plan, on the other hand – will have a PA matching the contributions more like $1 for $1, so there is less of an impact.

Cheers

20 Mike Holman

@Eclectic – Yes, good point about the DB pension contributions taking up RRSP room. I didn’t think of that.

21 Eclectic Investor

@ Mike

Re: … good point about the DB pension contributions taking up RRSP room.

Oh … the harsh lessons of life!
*grin*

Cheers

22 Canadian Performer's Money

I have never heard of dividends from Canadian companies affecting OAS payments. I thought the joy of dividend income is that it’s not considered income the same way as money withdrawn from an RRSP or RRIF so doesn’t create the same claw-backs?

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