Reviewing the differences between an RRSP and TFSA can help savers decide on how to choose one or both. The RRSP and TFSA are both savings vehicles, but often have different purposes, not to mention different rules and regulations governing each.
As with many investment decisions, taxes often tip the balance in favor of one or the other.
The RRSP is a tax-deductible retirement account. An individual’s contributions lowers taxable income in the year they contribute to an RRSP. The earnings will grow tax-deferred, but when it’s time to withdraw funds, RRSP account-holders pay taxes on the withdrawals at the tax rate when the money is withdrawn.
A tax-deductible RRSP is attractive for those who expect to be in a lower tax bracket when they retire. For example, if an account holder pays 30% taxes when working and then 20% in retirement, he or she is ahead of the game.
In comparison, the TFSA allows tax-free withdrawals. There is no tax deduction up front with contributions, but withdrawals — both in the form of contributions and earnings — will be 100% tax free.
Which is better? There’s no right answer, but first consider current income. Annual incomes of $50,000 or less are taxed in a lower bracket than higher incomes, so the up-front tax break may be minimal. It often makes sense to save using a TFSA in this scenario.
With annual earnings of greater than $50,000, the RRSP generally gets the nod based on the assumption that one’s tax rate would be lower when it’s time to make withdrawals.
Also, there are non-tax considerations. In 2022, a TFSA has contribution limits of $6,000 annually and $81,500 for the life of the account. For an RRSP, the limit is up to 18% of income, or $29,210, for 2022 — there is no lifetime maximum contribution limit for RRSPs.
Another important consideration for members of a group RRSP is whether the plan sponsor makes a matching contribution: Some employers will match 100% of the employee contribution, amounting to “free money” accessible at retirement.
But whereas an RRSP is taken out of a paycheck, individuals can set up and make contributions to a TFSA on their own, regardless of employment status.
And while withdrawals can be made at any time for both vehicles, note that by age 71, RRSP accounts must be collapsed, with distribution taken out as a lump sum or an annuity, or converted into a registered retirement income fund (RRIF).
Beware of the clawback
When deciding which investment vehicle is the best fit, consider that government benefits can get “clawed back” once an individual is above a certain income level. Low and moderate earners for the guaranteed income supplement (GIS) will lose 50 cents in benefits for every dollar they withdraw from an RRSP.
In addition, those with incomes above $79,054 will see 15% of their Old Age Security (OAS) pension clawed back for every dollar in additional income received from any source, including RRSP withdrawals or RRIF payments.
So, consider all implications, including taxes and benefit clawbacks, when planning retirement account withdrawals. However, planning can begin decades earlier. Although it’s hard to predict the future, it’s worth considering these financial risks when evaluating which account to save in.
Contact a HUB International Group Retirement advisor on the best path for financial independence.