Episode 9: The Investing King of Ring- RRSP vs TFSA

[00:00:00]  Intro Music

[00:00:05]  Welcome to the Retire Ready Podcast, the podcast that helps Canadians prepare for all that retirement brings. I'm your host, Scott Sather, Founder, President, Financial Planner at Awaken Wealth Management, and Portfolio Manager with Awaken Investments of Aligned Capital Partners in Regina, Saskatchewan.

[00:00:20]  Thanks for joining me today. Now, the big question many Canadian retirement investors have is: should you invest through the RRSP or the TFSA? Both have their pros and cons, so we're going to explore those today and talk about which option is the best for which situation. Before I jump in, though, if you want to get the details on these two different registered accounts in Canada, then you should go listen to the last two episodes of the podcast, where I go in-depth on the ins and outs of the RRSP and the TFSA. For today, we're assuming you've already listened to those episodes and know the basics of the accounts. All right, let's get started then. The question of whether you should invest in the RRSP or

[00:01:00]  the TFSA is easily answered with "it depends," as it really depends on why you're investing and what your individual situation looks like.

[00:01:08]  Using both accounts likely makes a lot of sense, but different situations mean using different accounts. For example, if you're saving for something short-term, like a holiday or emergency fund, or even a bigger purchase like a vehicle, the TFSA is likely the best option as it will allow you to invest tax-free, meaning no tax consequences on withdrawal. You'll receive your contribution room back the following year after your withdrawal, allowing you to continue to use the account for saving for another goal. If you're looking at buying your first house, then definitely look at the First Home Savings Account (FHSA) as it's the best option. This account allows you to save tax-free as your contribution is tax-deductible.

[00:01:49]  The growth inside is tax-free as long as it's used for a house purchase, and if it isn't, you're able to transfer the funds to your RRSP without any RRSP contribution room.

[00:02:00]  But we're talking RRSP versus TFSA, so let's get back to that.

[00:02:03]  After the FHSA, the next best place to save for a first-time homebuyer is likely using the RRSP and a Home Buyer's Plan withdrawal. After that, the TFSA then makes sense to save for that down payment. You can find more info on the FHSA in the show notes if you visit retirereadypodcast.com and visit the Episode 9 page.

[00:02:24]  If you're already in a house and looking to upgrade by saving a bit more for that down payment, then the TFSA would probably be the better option as the First Home Savings Account and Home Buyers Plan would likely no longer be available to you. If you're withdrawing otherwise from that Home Buyer's Plan, any withdrawals are taxable to you from the RRSP. If you're looking to go back to school to upgrade your education, then the RRSP can be a great option using the Lifelong Learning Plan, followed again by saving through the TFSA. Again, more info on these strategies will be available in the show notes.

[00:02:59]  Since this is a retirement-focused podcast, we should discuss which of these accounts are the better options for your retirement savings.

[00:03:06]  While the RRSP actually has retirement savings right in the name, it might not always be the best option for everyone.

[00:03:13]  That's where looking at your own individual situation will define the best option for you. Generally speaking, the TFSA is likely the better option if your income is below $50,000. The RRSP is the better option once your income is over $50,000. That's due to the tax deductibility of the RRSP contribution from your taxable income and the corresponding tax rate you will pay. At the core of these two accounts, with all things being equal—rate of return and tax rate before and after retirement—these two accounts will actually end up with the same amount of money. However, when are all things ever equal?

[00:03:49]  That's why we're going to discuss some general recommendations when it comes to deciding between these two accounts. Also, the two are not mutually exclusive of each other, as I mentioned before, meaning that

[00:04:00]  you don't have to choose one or the other. In fact, you can and likely will need to use both to reach your retirement goals. As well, I should mention the investment side of these two accounts.

[00:04:09]  Again, stressing as I did in the last two episodes, these are just accounts, not investments. You hold investments within these accounts, and both have the same investment options available to you: high-interest savings accounts, guaranteed investment certificates (GICs), term deposits, stocks, bonds, mutual funds, and exchange-traded funds (ETFs)—they're all available to invest in these accounts. There is one difference, though, when it comes to those holding U.S. investments and those who are U.S. citizens. If you're heavily invested in U.S. stocks, an RRSP can be advantageous since the IRS doesn't recognize TFSAs as registered retirement accounts, leading to withholding taxes on U.S. income. RRSPs are recognized and avoid this issue. As well, since the U.S. doesn't recognize the TFSA, those who have to complete a U.S. tax return lose

[00:05:00]  that tax-free growth on the account. Now, coming back to that "all things equal" statement I made, very rarely are all things equal in these situations. For most retirement investors, we usually see them needing less in retirement than they did before. This results in an advantage for the RRSP. In the case where your income in retirement will be higher than before, then the TFSA definitely has an advantage. But let's go through the pros and cons of these accounts.

[00:05:26]  The biggest advantage of the RRSP is that the contribution is tax-deductible, meaning if you make $100,000 and you contribute $10,000, your taxable income is reduced by the contribution, resulting in only $90,000 of taxable income, and you'll likely receive a tax refund come tax time. In comparison, the TFSA is invested with after-tax dollars. So in that same example, making $100,000 and investing $10,000 in the TFSA still results in you paying taxes on the full $100,000. The TFSA

[00:06:00]  allows your dollars to grow tax-free, hence the name Tax-Free Savings Account, meaning you can withdraw those funds tax-free. In comparison, the RRSP grows tax-deferred, meaning that as long as it stays inside that RRSP account, you don't pay any taxes, but upon withdrawal, it is taxed at your marginal tax rate.

[00:06:19]  What's a marginal tax rate, you ask? Well, that's the rate of tax that the next dollar of income you earn is taxed at. So in the case of earning $100,000 in Saskatchewan, your marginal tax rate is 33% right now, meaning if you make one more dollar of income, you'll pay 33 cents of tax on that dollar. Depending on the size of the withdrawal, it may push you up to that next tax bracket.

[00:06:42]  Again, in the example we've been talking about, that next bracket starts at $111,734 in 2024. So let's say you withdrew $15,000 from your RRSP on that $100,000 of income. The amount over $111,734 is

[00:07:00]  now taxed in the next federal bracket, which is 38.5%, 5.5% higher than the amounts below $111,734. So $111,733 would be taxed at 33%, and the remaining $3,267 of that $15,000 withdrawal would be taxed at 38.5%. Now, take that same example of making $100,000 and withdrawing $15,000 from your TFSA—there's no tax consequences as the TFSA withdrawal is tax-free. That's a huge difference. Oh, and adding to all of that, the CRA has your RRSP provider hold back income taxes on your withdrawal to make sure they get their tax money.

[00:07:43]  So, if you withdraw between $0 to $5,000, they withhold 10%. From $5,001 to $15,000, it's 20%. And everything over $15,000 has 30% withheld.

[00:07:58]  So in an apples-to-apples

[00:08:00]  comparison, if you need $15,000 in your pocket, you could withdraw just that exact amount from your TFSA, but you would actually need to withdraw a total of $21,428.57 to net you the $15,000 after they withhold the 30% or $6,428.57, for those doing the math. Now, the actual amount of tax you will owe on the withdrawal will be calculated

[00:08:26]  come the next April when you do your taxes. So you might get a little bit back, or you might owe a little bit more. From a contribution standpoint, the RRSP likely has more ability for you to contribute to the account.

The TFSA is limited to $6,500 in 2024 as the amount you can contribute, whereas the RRSP is 18% of your earned income in the prior year.

[00:08:48]  So, if you make more than $94,444 in 2024, you're going to have more contribution room in the RRSP compared to the $6,500 in 2024 for the TFSA. Over time, it's expected that the TFSA

[00:09:00]  will have larger yearly increases to the contribution limit compared to the RRSP. For example, in 2024, we saw the limit go up by $1,000 in the TFSA, whereas the RRSP limit went up $650. This is due to the indexation rate difference between the RRSP, which is based on the Canadian average wage and salary, and the TFSA, which is based on the inflation rate in the country.

[00:09:23]  So, if you're looking to save as much as you can, the RRSP will likely be the better option for contributions, and the TFSA will likely be better for withdrawing. I have seen some couples where one spouse invests in the RRSP and the other in the TFSA, allowing for the best of both worlds and a great tax planning strategy in retirement. This might be something to discuss with your financial planner if you're not sure where to start. There are also pension plans, Old Age Security (OAS), the Canada Pension Plan (CPP), Guaranteed Income Supplement (GIS), and maybe even the Saskatchewan Pension Plan (SPP) in your

[00:10:00]  retirement, and these accounts all work together to provide you with the income you need in retirement. For some of you, the RRSP might not even be an option or a good option. That might be the case for those who have a large pension, as your RRSP contributions don't get the same tax-deferred growth as those without a pension. However, the RRSP can be great for early retirement planning and deferring tax to the future when you're in a lower tax bracket.

[00:10:28]  We often work with our clients who have pension plans to take advantage of the RRSP in those years between retirement and receiving their pension plan or Old Age Security, allowing for withdrawals at the lowest tax rate possible. If you retire at 60, your RRSP withdrawals will likely be tax-free in Saskatchewan as the lowest tax bracket doesn't start until you earn $15,135 of income in 2024. This is a great strategy for those who want to delay their pension or Old Age Security, and even deferring their Canada Pension Plan, to maximize

[00:11:00]  their payments when they eventually start, and to help ensure those payments are not clawed back due to higher income in their 70s and beyond. While the strategy and planning for your retirement is complicated, when done properly it can help you pay significantly less taxes over the course of your life, resulting in more money for you in retirement.

[00:11:21]  One thing I should mention before we end today's episode is that the RRSP does have a deadline each year. That's because you can contribute for the prior tax year up until the 60th day of the following year, which will be March 1st, 2024, in this case.

[00:11:37]  There is no deadline for TFSA contributions. However, I encourage you to contribute to your TFSA as soon as possible to start that tax-free growth sooner rather than later.

[00:11:47]  Outro Music