WRITTEN FOR LAWYERS FINANCIAL BY SAIJAL PATEL
We all have to pay our share to the tax authority. By our rough calculations, taxes represent half of the things that are coming for all of us. (Gulp). But RRSPs and TFSAs allow you to grow your savings tax-free and be a lot more strategic on the timing and amount of taxes you’ll pay.
Registered Retirement Savings Plans (RRSPs) allow you to defer your tax. When you contribute, you lower your immediate tax bill and put off the tax burden until later, when you’re retired.
There are no immediate tax benefits to contributing to your Tax-Free Savings Account (TFSA). You’ve already paid taxes on the money you contribute. But TFSAs offer a benefit RRSPs don’t: you’ll never be taxed again on those contributions – not while they’re growing, and not when you withdraw.
Both are great tools to help you shelter your investments from tax. If you’re deciding which one makes the most sense for you, here’s a list of differences to help you choose.
WHEN RRSPS MAKE SENSE OVER TFSAS
When your goal is to lower your immediate taxable income.
Investing in an RRSP gives you a tax deduction up front. The higher your income bracket, the greater the tax benefit you receive.
And because any unused contribution room can be carried forward, there’s an opportunity for you and your advisor to be strategic and contribute more in the years when your income is higher, and less in the years when your income is lower.
There are no tax-deduction benefits when you contribute to a TFSA.
When you want to contribute as much as you can.
Your RRSP contribution limit for the 2021 tax year is 18% of the earned income you reported on your 2020 tax return, up to a maximum of $27,830. Your TSFA limit for 2022 is $6,000.
When you and your spouse want to use tax-splitting strategies.
Spousal RRSPs allow you to reduce your tax liability now and in the future by splitting your income with your partner.
For example, if you earn more than your spouse or common-law partner, you can contribute up to your allowable limit to their plan under a Spousal RRSP. You get the benefit of the higher tax deduction now. And when your spouse or partner withdraws money from the plan in the future, they’ll be taxed at their tax rate, which will hopefully be lower than yours.
With a TFSA, there’s nothing stopping you from contributing to your spouse’s plan. But there are no tax benefits in doing so, since TFSA contributions are made with after-tax dollars.
WHEN TFSAS MAKE SENSE OVER RRSPS
When you need flexibility.
TFSAs can be used for any type of savings goal, while an RRSP is really only meant for the big one: your retirement.
That’s why you can withdraw money anytime from your TFSA without any penalties or tax implications. And you won’t lose contribution room when you do.
There’s no penalty if you withdraw early from your RRSP, but you will be taxed. Every RRSP withdrawal is subject to withholding tax and income tax and – worse—the contribution room is lost for good. The two exceptions: you can borrow from your RRSP tax-free and interest-free to purchase a first home (Home Buyers’ Plan) or to pay for your own education (Lifelong Learning Plan).
When you want to take advantage of the tax deferral indefinitely.
You can contribute to a TFSA for as long as you live.
RRSPs, on the other hand, expire at the end of the year you turn 71. That’s when you’re forced to convert it into a Registered Retirement Income Fund (RRIF) or buy an annuity. Most people convert their RRSP to a RRIF and start drawing a regular income based on a formula. Retirement saving becomes retirement spending, and your RRIF income becomes subject to tax.
When you don’t want to be subject to government benefit clawbacks.
The money you draw from your RRSP or RRIF is considered taxable income and may affect your government income-tested benefits. That means benefits like Old Age Security (OAS), Guaranteed Income Supplement (GIS) and Employment Insurance (EI) payments can be clawed back.
For example, if you reported more than $79,845 of before-tax income in 2021, you would have to repay OAS. The clawback: 15% of your income above that threshold. If you made $10,000 above that threshold, you’d have to repay $1,500.
Funds withdrawn from a TFSA are not taxable and therefore not subject to such clawbacks.
While there are pros and cons to RRSPs and TFSAs, I’ll leave you with this thought: most people can’t say for certain what their personal tax situation and Canada’s tax rates or laws will be 10, 20 or 30 years from now. That’s why – if you can swing it – it’s worth using both.
We can help.
Talk to a Lawyers Financial advisor to decide whether to invest in an RRSP, a TFSA, or both.
Saijal Patel is the creator and host of Canada’s only national personal finance TV program, “Strictly Money,” and the founder of Saij Wealth Consulting Inc.