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January 26, 2020

TFSA or RRSP? 2020

One of the most common investment questions Canadians ask themselves today is, “Which is better, TFSA or RRSP”?

Here’s the good news – it doesn’t have to be an either or choice.  Why not do both? Below are the features of both plans to help you understand the differences.

Tax-Free Savings Account (TFSA)

 Any Canadian resident age 18 or over may open a TFSA. Contribution is not based on earned income.  There is no maximum age for contribution.

  • For 2019 and 2020, the maximum contribution is $6,000.
  • There is carry forward room for each year in which the maximum contribution was not made. For those who have not yet contributed to a TFSA, the cumulative total contribution room for 2019 is $63,500.  This will increase in 2020 to $69,500.
  •  The deposit is not tax-deductible, but the funds accumulate with no income tax payable on growth.
  •  Withdrawals may be made at any time on an income tax-free basis.  Withdrawals create additional deposit room commencing in the year after withdrawal.

Registered Retirement Savings Plan (RRSP)

  • No minimum age for contributing but must have earned income sufficient to generate RRSP contribution room.
  • Maximum contribution is 18% of earned income based on your previous year’s earnings to a maximum of $26,500 (for 2019). The maximum contribution for 2020 is $27,230.
  • There are carry forward provisions for years not contributing.
  • Contribution is tax-deductible from earned income, and the funds accumulate on a tax-deferred basis.
  • All withdrawals are taxable as income at top rate of tax based on earnings in the year of withdrawal.
  • RRSP ends in year contributor turns age 71, when the RRSP must be converted to a Registered Retirement Income Fund (RRIF) or life annuity and taxable income taken.

The advantages and disadvantages of both

  • Both programs provide for no tax on the earnings on the contributions, no difference there; however, only the TFSA allows for tax-free withdrawals.
  • A good habit to get into is to reinvest the tax savings from your RRSP contribution.  This maximizes your retirement savings with additional tax-deferred growth.
  • Or you might want to consider using your tax savings or refund created by your RRSP contribution to fund your contribution to your TFSA.
  • Be careful not to over value your RRSP balance.  The total value of your RRSP will be reduced by the tax payable upon withdrawal.  Tax is also payable upon death if the beneficiary is anyone other than your spouse.
  • RRSP works best for those people who will retire in a lower tax bracket.

The bottom line?

 Unless the tax savings from the RRSP are routinely reinvested, at the end of the day, there is little or no difference between the results of a TFSA or an RRSP. 

Want maximum results?  Take your RRSP tax savings and reinvest it to have great impact on your retirement savings.

Consider this: 

  •  If you invest $5,000 per year in an RRSP for 20 years at 5% compound growth, tax-deferred at the end of 20 years you will have $173,596.
  • If you were to invest the $1,750 tax savings (based on a 35% tax bracket) for 20 years your RRSP will grow to $234,355.  That is an additional $60,759 in your retirement savings!
  • Of course, you could choose to reinvest the RRSP tax savings of $1,750 in a TFSA where it will accumulate tax-free to the same $60,759 but the advantage here is you can withdraw this without tax.

Connect with me to discuss how you can optimize the use of both of these retirement vehicles.  As always, please feel free to share this information with anyone who would find it of interest.