I’m routinely asked by clients whether they should be using Registered Retirement Savings Plans (RRSPs) or Tax-Free Savings Accounts (TFSAs) for their retirement savings. Unfortunately, there isn’t a “one size fits all” answer to that question. The right answer is dependent on several factors in the individual’s situation.
The complexity is due to the opposing tax nature of RRSPs and TFSAs. RRSPs earn you a tax deduction when you make the contribution, grow tax deferred, and redemptions are fully taxable as income. TFSAs have no tax break for contributing, grow tax free, and redemptions have no tax consequences whatsoever. With those traits in mind, let’s look at why you may choose one over the other when it comes to retirement.
• Your taxable income today will be much higher than in retirement years. If you can project that your income in retirement will be in a much lower tax bracket than it is today, RRSPs may offer you significant advantages. For example, a person who invests $1,000 into an RRSP at a 40% tax bracket will save $400 in income tax. If they withdraw that $1,000 at a 25% tax bracket it will cost $250 in income tax, netting you a $150 profit!
• You’re planning around pension income. If your employer provides you with a reasonable pension plan, you may consider TFSAs your investment vehicle of choice. Since TFSA redemptions aren’t subject to income tax, they are an ideal choice for lump sum withdrawals for big expenses (vacations, vehicles, gifts, etc.). Your pension will help with the routine expenses while your TFSA will be there for the one-offs.
• You need the tax break today. If you find saving for retirement a challenge, the immediate tax relief of an RRSP can make the process easier to handle. Setting aside regular amounts and receiving tax refund each year can make all the difference in balancing a household budget.
• You have other goals that may interfere with retirement. Let’s face it, we are all balancing multiple goals and priorities with our money. Retirement might be your #1 goal, but hot on its heels could be helping with a child’s education costs, a second property, a business opportunity or a much needed holiday! If you feel there is a high likelihood that your retirement funds could be diverted away from retirement, a TFSA will offer far fewer tax consequences for non-retirement withdrawals.
The decision to save between a TFSA or a RRSP is a big one. There are immediate and long-term repercussions, so don’t take it lightly. Consider how you will use the funds down the road and commit to a plan! Your retirement will thank you.
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