TFSA or RRSP? Try these five tests

Reading time: 2,159 words, 6 pages, 5 to 9 minutes

It’s Canadian tax time again and both old and young may be confused about the differences and benefits of contributing to RRSP’s versus TFSA’s so reprinted in their entirety are two excellent articles by The Star’s Gordon Pape.

February 26, 2013

TFSA or RRSP? Try these five tests

The Star

Tuesday, February 19, 2013
11:36 AM EST

There is a lot of confusion over whether it’s better to use an RRSP or tax-free savings account (TFSA). Here’s how to figure it out.

By: Gordon Pape Building Wealth, Published on Sun Feb 17 2013

There is a lot of confusion over whether it’s better to use an RRSP or tax-free savings account (TFSA) to save. Unfortunately, there is no easy answer. There are several variables to consider.

To simplify matters, I’ve created five tests that you can apply to help you make up your mind. Here they are, with some background on each.

The Age Test. Everyone between 18 and 71 can ignore this one. For those who are still reading, the test is very simple. If you are over 71, a TFSA is your only choice. All RRSPs must be terminated, either by cashing out or converting to an income stream by Dec. 31 of the year of your 71st birthday.

For those under 18, the RRSP is the only option because you can’t open a TFSA until your 18th birthday. Most teens wouldn’t even think about an RRSP, but if you have any earned income, perhaps from a summer job, you’re eligible to contribute.

The Pension Test. Anyone with a blue-chip pension plan should probably opt for a TFSA. That’s because they will have a secure income in retirement which will probably be above the national average. Withdrawals from an RRSP or RRIF, added to their pension, Old Age Security, and CPP, could push these people into a high enough bracket that some or all of their OAS benefits will be clawed back. This year the clawback kicks in when net income surpasses $70,954. At that point, the tax rate for an OAS recipient is higher than that assessed on someone with a million dollar income.

TFSA withdrawals are not considered to be income so they will have no impact on the clawback.

The Goals Test: Ask yourself about why you are saving. Is it for retirement? If so, the RRSP is generally the best choice because it has a much higher contribution limit. You can only put $5,500 a year into a TFSA but the RRSP limit is 18 per cent of the previous year’s earned income to a maximum of $23,820.

If you are saving for a short-term goal, such as to buy a car, use a TFSA. If you put the money into an RRSP it will be taxed coming out, perhaps at a higher rate than your contribution deduction was worth.

A TFSA is also the best choice for an emergency fund. If something unexpected happens, such as a job loss or critical illness, you’ll want to be able to get at your money quickly, without having any held back for taxes.

For education savings, neither an RRSP nor a TFSA is the best choice. Instead, opt for a Registered Education Savings Plan (RESP) where the federal government will also make a contribution on your behalf of up to $500 a year.

The Support Test: Do you expect to need government support in your later years, such as the Guaranteed Income Supplement (GIS)? Then choose the TFSA over the RRSP. GIS payments and provincial support programs are income tested. In the case of GIS, single people drawing OAS will lose $0.50 on every $1 for any other income except OAS and the first $3,500 of employment income. If income exceeds $16,560, the GIS disappears completely.

RRSP withdrawals and RRIF payments count as income for GIS calculations. This means that lower-income people who scrimped to put some money aside in an RRSP for retirement are penalized. You won’t have that problem with TFSAs because the withdrawals are not considered as income for the GIS calculation.

The Income Test: Do you have any idea what your income is likely to be after retirement? If you do, it makes the TFSA/RRSP choice a lot easier. If your income will be lower than when you were working, go for the RRSP. Here’s why. Let’s say you’re in a 35 per cent tax bracket. For every $1,000 you contribute to an RRSP, the government gives you back $350 as a tax refund. Your net cost is $650.

Let’s assume that in retirement, your marginal tax rate will fall to 25 per cent. You’ll pay $250 in tax for every $1,000 you withdraw from the plan. That’s a good deal from a tax perspective.

It’s the reverse if your income will be higher in retirement. For example, suppose your pension plan allows you to retire with full benefits after 30 years of service. You may decide to quit while you are still in your fifties and open a consulting business. With that income plus your pension you expect to make a lot more money than when you were an employee.

In this case, the TFSA is the better choice. The contributions will have been made with after-tax money when your marginal rate was 35 per cent. But if you later move to a 40 per cent rate, those tax-free withdrawals are going to look pretty attractive.

Gordon Pape is editor and publisher of the Internet Wealth Builder newsletter. His website is . His latest book, Retirement’s Harsh New Realities, is available at StarStore.


RRSPs better for retirement than Tax-free account

Tax-Free Savings Accounts are a great way to save, but for 90 per cent of people an RRSP is the way to go. Here’s why.

By: Gordon Pape Published on Sun Jan 22 2012

Last week, I was a guest on a Montreal phone-in show that focused on retirement planning. One listener, named Dave, called in with a question that, frankly, astounded me.

He said he was in his early thirties and was concerned about saving for retirement. He had contributed every year to a Tax-Free Savings Account (TFSA) and had no room left. He wanted to save more but had “always been advised not to put any money into RRSPs.” What would I suggest?

My first reaction was that he should take advice from someone else. I find it difficult to imagine why anyone so young should be told to stay away from registered RRSPs.

Don’t get me wrong. I think TFSAs are a great way to save and we are very fortunate to have them as an option. But for 90 per cent of people, they should not be the number one choice for building a retirement nest egg. The RRSP is the go-to vehicle for that purpose.

I told Dave that at his age the number one savings priority is to get as much money as possible into a tax-sheltered environment. That will maximize the benefit of long-term compounding. The RRSP is the easiest way to do that, for two reasons.

First, contribution limits are much higher. You still can only put $5,000 a year into a TFSA — the inflation factor won’t kick in until 2013 when the limit will move to $5,500. With an RRSP, you can contribute up to 18 per cent of last year’s earned income to a maximum of $22,970. Most people obviously won’t be in a position to put that much into a plan but you have the leeway to contribute more than you can to a TFSA.

Second, you get a tax deduction for your RRSP contribution which is not the case with a TFSA. For example, an Ontario resident earning $50,000 who contributed $5,000 to an RRSP last year will get a refund of $1,558 when she files her 2011 tax return. A person earning $75,000 who contributed $7,500 will receive $2,474 from the government.

Since the phone-in show, I have been trying to imagine who might have told Dave not to contribute to an RRSP. I can’t imagine it was a qualified financial adviser — it would actually be in an adviser’s best interests, as well as Dave’s, to encourage RRSP contributions because of the fees that would be generated.

I came to the conclusion that it must have been some curmudgeonly older relative who was angry about paying taxes on the money being withdrawn from an RRSP or RRIF. I hear that sort of thing a lot. “If I had only known how much tax I would have to pay, I never would have saved in an RRSP.”

It’s true that RRSP and RRIF withdrawals are taxed at your marginal rate. It’s also true that the government requirements for minimum RRIF withdrawals are much too high — 7.38 per cent at age 71 and increasing annually from there.

But people who complain about the taxes are losing sight of two basic points. The first is that they received a nice deduction at the time of the original contribution and then were able to invest the money tax-free for many years. The second is that they are fortunate to have enough income in retirement to pay any taxes at all. Many Canadians do not.

Having made these points, there are a few exceptions to the RRSP before TFSA rule. Here they are.

1. Older people. You must wind up your RRSP at the end of the year you turn 71 so it is no longer a savings option once you’ve reached that age. But an increasing number of people are working long past 71. I’m 75. Iconic actor Christopher Plummer, who just won a Golden Globe Award, is 82. Recently, a national television news show featured the story of an 84-year-old man in Alberta who still works full-time delivering bottled water. While most people have stopped work by the time they hit 70, an increasing number keep right on going. For them, the TFSA is the only tax-sheltered savings option available.

2. Your income is low and you expect it to stay that way. If your post-retirement income is likely to be low (below $16,368 for a single person) you may qualify for the Guaranteed Income Supplement (GIS). However, there are some restrictions. If other sources of income including RRSP/RRIF withdrawals exceed the allowable exemption, which is $4,448 not including Old Age Security and the first $3,500 of employment income, your GIS payments will be clawed back. The effective rate is $0.50 on the dollar. TFSA payments are not counted as income so they won’t affect your benefits.

3. Your income will be higher in retirement. This happens more often than you might think. For example, a teacher might retire on full pension at a relatively young age after 30 years on the job and open her own tutoring business. Her total income from the business, her pension, and her savings might well put her into a higher tax bracket than when she was working full time. In this situation, the tax on RRSP withdrawals would be higher than the deductions she received for her contributions.
Moving from a low-tax province such as Alberta to a high-tax one like Nova Scotia can have a similar effect.

4. Pension plan members: Anyone who belongs to a pension plan loses RRSP contribution room because of the “pension adjustment” (PA). This is a complex calculation that takes into account the amount contributed to a pension plan by you and your employer, as well as the retirement benefit you will eventually receive. The more generous the plan, the higher the PA will be.

If you have a defined benefit pension plan (one that provides guaranteed retirement income based on a combination of salary and years of service) you are likely to have a high PA. As a result, you may have little or no RRSP room left after the PA has been deducted. In this situation, TFSAs offer a valuable alternative for supplementing pension income.

5. No earned income. You cannot make an RRSP contribution unless you have what the government calls “earned income.” Mostly, this is money earned from employment, but some other types of income, such as rents and alimony, also qualify. Investment income does not count as earned income, nor do pension payments, whether from the government or from a private plan. If you don’t have any earned income, or if the amount is small, TFSAs become your retirement savings vehicle by default since you don’t need any earned income to make a contribution.

As I said at the outset, for most people the RRSP is the better way to go for retirement savings. But be sure you don’t fall into one of the above five categories before making a final decision.

Gordon Pape is editor and publisher of the Internet Wealth Builder newsletter. His website is His latest book, Retirement’s Harsh New Realities, is now available.


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About gerold

I have a bit of financial experience having invested in stocks in the 1960s & 70s, commodities in the 80s & commercial real estate in the 90s (I sold in 2005.) I'm back in stocks. I am appalled at our rapidly deteriorating global condition so I've written articles for family, friends & colleagues since 2007; warning them and doing my best to explain what's happening, what we can expect in the future and what you can do to prepare and mitigate the worst of the economic, social, political and nuclear fallout. As a public service in 2010 I decided to create a blog accessible to a larger number of people because I believe that knowledge not shared is wasted.
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