As you think about maximizing your contributions to either your TFSA or RRSP before tax season? (The RRSP contribution deadline is March 1st, 2023). Or, are you wondering where to invest the tax return that you’ll get back?
In an ideal world, you’d be able to max out your contributions to both a TFSA and RRSP, every year. Realistically though, you’ll have a set amount you can contribute, and you’ll want to focus on where you can make the most earnings and pay the least tax. That means answering the question: right now, should I put my money into a TFSA or RRSP?
Let’s start with a quick summary of each account type before moving on to guidelines for when to invest in either option at your phase of life.
TFSAs vs. RRSPs
What is a TFSA?
Tax-Free Savings Accounts (TFSAs) can hold investments, including mutual funds, stocks, bonds, and exchange-traded funds (ETFs). You can contribute to your TFSA with your after-tax dollars, meaning that after tax is taken off your paycheque, you can allot some of your income to investing in this account.
What are the main advantages of a TFSA?
The biggest advantage of a TFSA is that the capital gains you earn inside it from your investments are not subject to tax, and you won’t pay tax when you withdraw from your TFSA either.
Another benefit is that you can withdraw money from your TFSA anytime for any reason, keeping in mind that you may be subject to the terms of any specific investments within your TFSA.
How do TFSA contributions work?
You can open up a TFSA as soon as you turn 18. The amount you’re allowed to contribute to a TFSA in 2023 is $6500, with any unused from previous years carrying forward. If you’ve never invested in a TFSA before, you have $88,000 worth of contribution room in 2023. If you haven’t completely used your contribution room in the past, you might also have thousands or even tens of thousands of dollars of contribution space ready for you to maximize right now.
How do TFSA withdrawals work?
If you withdraw money from your TFSA for any reason, your contribution room gets adjusted and added back in for the next year. So, you can make up for those withdrawals at any time.
What is an RRSP?
Registered Retirement Savings Plans (RRSPs) are tax-deferred accounts primarily geared toward saving for retirement. You pay no tax on the earnings inside the RRSP until withdrawal. Like with TFSAs, you can hold many types of investments inside of an RRSP.
What are the main advantages of an RRSP?
Your RRSP contributions are tax-deductible and have an immediate benefit in that they can move you into a lower tax bracket for the year you contribute. Since tax is deferred, when you do eventually withdraw money from your RRSP, the idea is that you’ll be retired, which also means a lower tax bracket and paying less tax on the withdrawals.
How do RRSP contributions work?
There’s no minimum age for opening an RRSP, so it’s a good idea to open one as soon as you start working. However, until age 18, you’re limited to contributing $2000 per year.
There’s a maximum age for investing in RRSPs though: 71.
Your annual contribution room for an RRSP is 18% of your earned income for the previous year, up to a maximum of $29,210 for 2022. Like with a TFSA, any unused contribution room from previous years carries forward to the next, so if you’ve never opened an RRSP before or maximized your contributions, you could have thousands of dollars in available contribution room.
How do RRSP withdrawals work?
Importantly, RRSPs have regulations around when you can withdraw money without paying tax, namely the Home Buyers and Lifelong Learning programs. The former is for making the deposit on your first home, and the latter is for going back to school. The benefits of these programs are that neither withdrawal type is taxable, and you get to keep the contribution room to make up for the withdrawals in the future.
In contrast, if you withdraw money from your RRSP for any other reason before retirement or the account’s maturity at 71, you’ll both pay tax on it at your current tax bracket, and you’ll permanently lose that contribution room.
TFSAs vs. RRSPs: Top 3 Factors to Consider
When deciding between contributing to a TFSA or RRSP, these are the top 3 factors to consider:
- Tax Bracket: The tax-deductible benefit of an RRSP is more significant if you’re in a higher tax bracket.
- Investment Horizon: If you have a long-term investment horizon (such as 10-20 years), an RRSP may be more advantageous because the tax is deferred, meaning you have more capital to invest and reinvest inside the account until withdrawal. A TFSA is generally better for short-term savings where access to funds is more important than the potential return on investment since that return would be limited by a short investment horizon anyway.
- Savings Goals: Consider your savings goals and whether you need immediate access to the funds. If so, a TFSA is often more suitable, as it allows for tax-free withdrawals at any time, without penalty, regardless of the reason. However, remember to consider if any investments inside your TFSA have their own term limits, as this can prevent you from immediately accessing your money.
Should I contribute to a TFSA or an RRSP?
Now that we’ve reviewed the basics of TFSAs and RRSPs, let’s apply the Integrity Tree Financial approach and consider where to maximize your contributions in your current phase of life. Remember, for more personalized guidance, please reach out for a free consultation
Choosing a TFSA vs. RRSP by life goal
Is travel one of your biggest dreams for the upcoming year(s)? Will you need to dip into one of these accounts to make it a reality? A TFSA is your best bet. Here are a few of the reasons:
- You can withdraw money from your TFSA whenever you want, for whatever reason you want, including travel, without losing the contribution room.
- You’ll avoid a tax hit when withdrawing money from your TFSA, whereas an RRSP is taxed when you withdraw money prematurely for any reason except special programs.
- When you withdraw money from a TFSA, you’ll generally receive the funds within just a few days.
Buying a home
Is this the first home you’ll ever buy? Your answer to this question makes the difference in whether you should use an RRSP or TFSA to save for this purchase.
If you’re buying your first home, you can withdraw $35,000 from your RRSP to use towards your down payment as part of the Home Buyers program.
If this isn’t your first home purchase, a TFSA is the way to go. You can withdraw from your TFSA anytime, and for any reason without penalty. That means you can use this money towards a down payment, mortgage payments, or renovations on your new place. If you were to withdraw money from your RRSP to do so, you’d pay tax according to your current tax bracket and lose the contribution room. Instead, your withdrawal is tax-free from your TFSA, and you get to keep the contribution room.
Starting a family
It’s important to invest in your RRSP to build for the future, but if you’re about to get married or have your first child, the quick, tax-free accessibility of funds in your TFSA can be a lifesaver. You can withdraw money from a TFSA anytime (assuming your investment terms pose no issue) and for any reason, so the funds can help cover the cost of a wedding, honeymoon, or new baby.
Going back to school
The Lifelong Learning Program means you can withdraw up to $10,000 per year, tax-free, from your RRSP to pay tuition when going back to school. You also get to keep the contribution room with this program. So, if going back to school is on the horizon, or you’ve graduated and want to build back up your savings, contribute to your RRSP.
Saving for retirement
The sooner you start saving in an RRSP for retirement, the better. The longer your contributions can compound interest and earn you capital gains on long-term investments, the more money you’ll have when it’s time to withdraw the earnings in retirement at a lower tax bracket.
However, the maximum age to contribute to your RRSP is 71. So, if you’re already maxing out your RRSP contributions and/or will work past 71 and want to continue saving and investing for retirement, contributing to your TFSA is a great option. While you’ll be contributing your after-tax dollars to the TFSA, there’s no maximum age limit, and you won’t be hit by taxes owing when it’s time to withdraw money for retirement.
Leaving an inheritance
There are benefits to using both your RRSP and TFSA to leave a legacy for family, friends, or a cause you believe in.
Both RRSPs and TFSAs can be left to a spouse or common-law partner tax-free. In the case of a TFSA, you need to name a spouse or common-law partner the “successor-holder” of the TFSA, which transfers all ownership rights to them, meaning they can receive the benefits of the TFSA as if it were their own. For any other named beneficiaries on the TFSA, there are also no taxes paid, except on earnings made on the account after the date of death. However, for an RRSP, taxes are applicable for all other beneficiaries unless those beneficiaries were dependents.
Ready to contribute to a TFSA or RRSP?
Remember, your financial picture is as unique as you and your vision for the future. For more personalized advice, especially when you’re excited about more than one of the above life goals, reach out to our team at Integrity Tree for a free consultation