RRSP vs TFSA: What’s Right For You

A topic of conversation that’s frequently brought up with my clients is about savings and retirement. As a common discussion, it’s important for everyone to learn more about the difference between RRSPs vs TFSAs and the benefits of both. When considering which savings plan to pursue, there is no one-size-fits-all. Your financial situation is unique, your goals are unique, and at the end of the day you need a plan that will benefit your life. Let’s dive in.

 A Registered Retirement Savings Plan (RRSP) is contributed to by yourself, and either your spouse or common law partner. A big bonus for having an RRSP is that there are deductible contributions that can be used to reduce the amount of tax you pay.

Any income you earn in the RRSP is usually exempt from tax as long as the funds remain in the plan. Generally, you have to pay tax when you receive payments from the plan. When we say payments from the plan, we refer to the amount that you earn back from tax deductions.

With a handle on the basics of an RRSP, we can take a look at RRSP vs TFSA.

TFSA

RRSP vs TFSA – Which Saves Your More Money?

Honestly, this all depends on your own individual circumstances, tax situation, and when you want to take the money out of the account. To get a realistic answer to this question, contact your accountant to discuss further. If you need an accountant, I have always offered free consultations to new clients, so give me a call and we can discuss further in detail.

Which One Is Right For You?

When it comes to RRSPs and Tax-Free Savings Accounts (TFSA), there are a couple things to consider. These considerations will help you decide which plan will be best you. So the question is, which plan do you choose, or do you contribute to both?

To analyze this decision for yourself, the first tool you will need to be familiar with is how “Marginal Tax Rates” work. Simply put, when you move from one tax bracket to the next, it’s the amount that is earned in the high bracket that is taxed at a higher rate and not the entire amount of your income. 

Here’s an example to better explain how taxation brackets work:

In B.C., if Jim makes $38,898 in 2017, this means he will pay tax on this amount at a rate of 20.06%.

If Jim made $45,916 in 2017, he would still pay 20.06% on the first $38,898. Additionally, he would pay 22.7% on the next $7,018 ($45,916 – $38,898).

If Jim made $77,797 in 2017 he would still pay 20.06% on the first $38,898, plus 22.7% on the next $7,018 ($45,916 – $38,898), as well as 28.2% on the next $31,881 ($77,797 – 45,916).

The second tools you need to analyze what this means to you specifically (because you’re not Jim) is that…

When you withdraw money from an RRSP, you pay tax at your “Marginal Rate” at the time of withdrawal.

Jim made his RRSP contributions when his Marginal Rate was 20.06% and he now withdraws his RRSP when his marginal rate is 28.2%. That means he is actually losing money in the long term!

Alternatively, Jim contributed to his RRSP when his marginal rate was 28.2% and withdraws his RRSP when his Marginal Rate is 20.06% – he gains money.

Now we’ve discussed how the contribution creates a refund and how the withdrawal of that contribution is taxed, let’s compare how the different investment growths of RRSP vs TFSA are taxed.

If the lifetime contribution to either an RRSP or a TFSA was $300,000 and the lifetime investment income earned was $100,000, your total future withdrawals will be $400,000.

When you withdraw this amount from your RRSP, you will pay tax at whatever your future Marginal Rate. However, when you withdraw this same exact amount from your TFSA, you will pay ZERO TAX.

So, since we know that TFSA is not taxable, this means that the decision point that is most relevant is the following:

“Does the immediate tax savings help me in the long run?”

Remember:

The deadline for contributing to your Registered Retirement Savings Plan (RRSP) for the 2016 tax filing year is March 1, 2017.