RRSP or TFSA?

A road sign that shows 4 different "right ways"

This article is by freelance writer, Sharon Skwarchuk. Ironically, due to my busyness and procrastination I didn’t get this posted before the 2017 RRSP deadline. So don’t be me – don’t wait until the last minute. Start your investing ASAP using automatic contributions so you don’t miss next year’s deadline – Meena

RRSP Basics

So it’s RRSP season once again.  What exactly is RRSP season?  It’s the time of year when people start thinking about filing their tax returns, and whether or not they need to buy RRSPs in order to create or increase a tax refund.  The RRSP deadline for 2017 is March 1, 2018.  This means that if you want to contribute to your RRSP for the 2017 tax year, you must do so by March 1, 2018.

Many people, including me, wonder if the RRSP is still the best solution for our retirement savings.  Not so long ago, it was really the only option for reducing your potential taxes while saving for retirement.

There are a number of rules that must be followed with respect to RRSP contributions and withdrawals.  But in a nutshell, the reasoning behind an RRSP is this: 

You put money into it now while your income is higher.  The money you deposit does not get taxed until you withdraw it, hopefully at retirement.  And when you retire, your income will be lower (and you may have more tax credits), so the amount of the tax that you pay at withdrawal will be less than you would have paid when you earned the money. 

That’s the logic, which makes sense if you can actually go the distance and not withdraw the money before retirement.  But how realistic is that? 

Withdrawing RRSPs

Speaking for myself, I had managed to save up about $25,000 in an RRSP over about 15 or 20 years.  Then the oil recession hit Alberta, and my boyfriend‘s hours started getting cut.  His annual income dropped from $110,000 to less than $30,000 over a three year period.  When he got laid off, he was out of work for almost 15 months.  And when you’re trying to make it on about less than half of what you were bringing in, you can’t get ahead – especially when you’re buying groceries and gas with your credit card.  So our bills started piling up.  I made the very difficult decision to cash in my RRSP. 

But as some of you probably know, when you cash in an RRSP, the financial institution withholds a certain percentage immediately, (just like your employer does on your paycheques) and then the actual tax owing is calculated when you do your tax return.  Needless to say, I ended up paying about 30% of that $25,000 to the government in taxes at a time when I really could have used that extra cash.  So this was a definite downside to RRSPs.

Something else people often do in February is take out an RRSP loan. There’s a separate article about them here. To summarize, I don’t usually recommend an RRSP loan.  An automatic savings plan throughout the year is a much better option.

TFSA Basics

So what about a Tax Free Savings Account instead of an RRSP?  With a TFSA, you are currently allowed to contribute up to $5,500 per year into the TFSA (plus unused amounts from prior years), and you don’t have to pay income tax on the interest that you earn within that account. 

Normally, you have to pay tax on any interest that you earn from an investment, but with this account, you don’t have to pay the tax.  So if you earn $300 in interest, you don’t pay tax on that amount.  That’s the great thing about this investment.  You can also withdraw money from this TFSA without having to pay taxes on your withdrawal, because the taxes were paid on the money before you put it into the TFSA. 

However, there are also certain restrictions with respect to this account, including how much you can deposit, so you need to make sure that you follow the rules. 

So which is better – an RRSP or a TFSA? 

Personally, I prefer a TFSA.  I want to be able to take out the money when I need it without having to pay tax on it.  Plus all the interest that I earn within the TFSA is tax-free.  And for some reason, I find it easier to contribute to a TFSA than I do an RRSP.  Don’t ask me why – I think it’s psychological.  I think I feel better knowing that I’ve already paid the taxes on this money, and when I withdraw it, I can have it all because the government has already taken their share. 

I also think that I prefer to contribute to a TFSA because it feels more like a choice than an obligation.   To me, an RRSP feels like an obligation- it’s like something you have to do because you’re a responsible adult.  And I hate it when people tell me that I have to do something.  

Finally, I want to say that I am not a financial advisor in any sense of the word. All I am giving you is my own personal opinion from my own research and my own experiences and observations.  As always, the final choice is up to you.

Meena’s Note:

As a financial planner, I can discuss with you the reasons why a TFSA or an RRSP is preferable in your situation. A case can usually be made for some of both. But on a strictly mathematical sense there is a rule of thumb to follow. (Unfortunately, it requires some guess work.)

   Your Situation                                                             Best Option

  • Current income is lower than planned retirement income             TFSA
  • Current income is higher than planned retirement income           RRSP
  • Current income is the same as planned retirement income          Either

I think the suggestion to contribute automatically monthly or bi-weekly is an excellent one. You earn more money by contributing throughout the year, and it’s easier on your budget, than doing the lump sum contribution next February. So start today! I’m working with the robo-advisor WealthBar, and they are an excellent tool for low cost, super easy investing – in TFSAs, RRSPs, and RESPs.

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