Each year, every Canadian adult gains additional TFSA contribution room, to a total of $88,000 in 2023 (for anyone who was 18 or older in 2009, the year the TFSA was introduced). Offering a combination of tax-free investment returns and withdrawals plus easy access to savings, the TFSA is often seen as the savings solution for “everything else,” while the good old registered retirement savings plan (RRSP) is preferred for retirement savings.
However, these two plans can complement each other. Let’s see how.
Understanding the RRSP and the TFSA
RRSPs and TFSAs are two tax-efficient savings solutions. In both cases, the money you invest is completely tax-sheltered as it grows. There is one major difference, however. The RRSP is a tax-deferral plan: your contributions are tax deductible, but all your withdrawals are considered to be taxable income. In the case of the TFSA, your contributions are not tax deductible. Your withdrawals, on the other hand, are not considered to be taxable income.
Another difference: when you turn 71, your RRSP has to be converted into a disbursement vehicle, such as an annuity or a registered retirement income fund (RRIF), from which you must make taxable withdrawals every year. There are no such restrictions on the TFSA, and you can continue using it as long as you want.
So… RRSP or TFSA?
To look at it mathematically, one particular factor holds the key as to whether it would be more beneficial, once retired, to have your money invested in an RRSP or a TFSA: your tax rate. As we can see here, the RRSP comes out the winner if your marginal tax rate is lower in retirement than it was when you were making contributions – which is often the case. In this situation, you would effectively pay less tax on your withdrawals than the amount you saved when making your contributions. But in the reverse situation, the TFSA would have the advantage.
If you expect your tax rate to be higher during retirement than it was when you made your contributions, it could be to your advantage to favour the TFSA. Here are two cases in point.
You are just starting out in your career and your income puts you in a lower tax bracket
You might be better off choosing the TFSA, even if you later withdraw some of that money to put into an RRSP once your income is higher and an RRSP contribution would give rise to a bigger tax deduction.
Your income for a particular year is much lower than usual
For the same reason, an RRSP contribution could be more advantageous in a future year.
Five more good reasons
Leaving tax rates aside, there could be other reasons not to ignore the TFSA in your retirement planning. Here are five:
1. TFSAs don’t affect Old Age Security
At age 65, all Canadians become eligible for Old Age Security benefits, but these have a “clawback threshold.” If your taxable income is over this threshold, you will have to repay some or all of your benefits. Since RRSP and RRIF withdrawals count as taxable income, they could put you over the threshold. That does not apply to a TFSA.
2. TFSAs have no impact on other income-tested benefits
For the same reason, TFSA withdrawals will not affect your eligibility for other government benefits based on taxable income.
3. TFSAs can compensate for a pension adjustment
If you belong to an employer-sponsored pension plan, your RRSP contribution room will be reduced by an amount known as your pension adjustment. TFSA contributions are not affected by the pension adjustment. So you could use a TFSA to tax-shelter money that you are not allowed to contribute to your RRSP.
4. TFSAs can easily be used at any time
In unforeseen circumstances, it could be helpful to have quick access to money you were saving for retirement. A TFSA can be more flexible than an RRSP in this regard. On the other hand, once you are retired, you don’t have any obligation to make withdrawals every year, as you do with a RRIF, for example.
5. TFSA dollar limits are not linked to income
Your annual RRSP contribution limit is based on your income from employment for the previous year. This is not the case with a TFSA. If you have some money – a small inheritance, for example – that you would like to put aside for retirement, but you don’t have enough RRSP contribution room, a TFSA could be useful.
Finally, one last advantage could present itself… when you die. In provinces or territories that recognize TFSA beneficiary designation, a survivor could be designated as a TFSA successor holder under certain conditions. If these conditions are met, the survivor could become the new holder of the TFSA immediately following the death of the original holder, without going through the estate settlement process. Note, however, that this is not the case in Quebec.
As we can see, a TFSA could really be useful “for everything else”… and for retirement. To find out how its advantages might apply in your situation, talk to your advisor.
The following sources were used to prepare this article:
Financial Consumer Agency of Canada, “Comparing retirement savings options.”
Canada Revenue Agency, “Tax-Free Savings Account (TFSA), Guide for Individuals.”
Autorité des marchés financiers, “Guide to Financial Planning for Retirement 2021.2022.”
CPA, “Investing in RRSPs or TFSAs: What’s right for you?.”
Desjardins, “FAQ – TFSAs”; “What's the difference between an RRSP and a TFSA?.”
C.D. Howe Institute, “Saver’s Choice: Comparing the Marginal Effective Tax Burdens on RRSPs and TFSAs.”
MoneySense, “RRSP vs. TFSA: Which is right for you?”; “TFSA vs RRSP: How to decide between the two.”