RRSP vs TFSA

By Fin MacDonald

As we look toward the annual RRSP contribution deadline of February 29 (yes, this is a leap year!) questions arise as to which registered plan would be best for an individual's investment. Using my lens of what lets you keep more of your money, let's look at what the RRSP and TFSA are.

Registered Retirement Savings Plan

RRSPs were introduced in 1957 but did not become widely used until the 1980s. Contributions may be made by people between the ages of 18 and 72. Designed to encourage Canadians to save for retirement they offer a reduction in tax payable by the contributor. The amount of the tax reduction varies with the taxable income of the contributor. The table shows the effect of a $5,000 contribution:

To contribute to an RRSP one must have contribution room. This is earned at a rate of  18% per year on eligible income to an annual maximum of $22,450. Added to this is any previous unused contribution room (the amount can be found on your 2010 Notice of Assessment.)

One does not need to take the deduction in the year it was made. An example: Brittany is 25, just out of UVic and earning $28,000 a year. She is able to make a $2,000 contribution which would entitle her to $465 refund. Brittany expects to be making $50,000 in the near future. By not taking the deduction this year she can increase her tax saved to $610 while still having the contribution grow tax free inside her RRSP.

When the funds from the RRSP are withdrawn they are subject to tax. If one is in a lower tax bracket, the tax paid will be less than the tax saved on contribution. As well, the contribution will have grown tax free inside for the length of time it was left inside. For example, with Brittany, if she leaves the contribution in her RRSP until after she retires it will have had 40 years to grown tax free!

RRSPs may also be used to save for a down payment for a first house (Home Buyers' Plan) where upto $25,000 per person may be withdrawn. This is then repaid over 15 years.

The year one turns 71 the RRSP must be converted into a Registered Retirement Income Fund or a Lifetime Annuity. Both of these generate taxable income that must be included in one's income. With the RIF the minimum amount required to be withdrawn increases from 7.48% at age 72 to 20% at age 94.

Tax Free Savings Account

The new kid on the block the TFSA is now in it's 4th year. Those 18 and over may contribute upto $5,000 per year. If one has not made a contribution to a TFSA before, in 2012 they have $20,000 in contribution room. Unlike the RRSP there is no deduction from taxes for TFSA contributions; but neither is it included in income when withdrawn. Like an RRSP, the TFSA contributions grown tax free inside the account until withdrawn.

RRSP vs TFSA

At different life stages and income levels one may be better than the other. Take a person, 73, taxable income of $65,000 and single. She is no longer eligible for RRSP contributions. She is also getting close to the OAS clawback income of $ 67,668 ($69,562 for 2012). Maximizing her TFSA contribution may make sense.

At the other end of the income scale, a 73 year old woman with a taxable income of $16,368 (not including OAS) would no longer be eligible for Guaranteed Income Supplement. Other means tested Provincial programs such as Pharmacare,  MSP Premiums, Bus Pass and Seniors' Supplement depend on one's net income. Any income that can be moved to a TFSA will help in retention of the various Provincial programs and subsidies.

Those contemplating retirement in the next 5 to 10 years should look at the consequences of having taxable income from their investments and whether it would be better to have non-taxable income. For younger folks the RRSP is probably the best option.

In conclusion the best advice I can offer to all is: SAVE!! With recent comments by opinion leaders about the extra $10 BILLION per year that will be required by 2020 for OAS payments one can be sure that governments will be looking to reduce expenditures and tax breaks where they can; use them while you can.