RRSPLast Call for RRSP Contributions!

It is never too early to start saving for retirement. And as tax season approaches, it is a good time to think about your options when it comes to tax-advantaged savings options. Two of the most common ways to save are RRSPs and TFSAs, so we wanted to look at each so you can determine which one (or both!) are the best option for your specific situation.

Registered Retirement Savings Plans (RRSPs)

When it comes to retirement planning, an RRSP is a popular way to save because it lowers your overall tax bill and brings compounded, tax-free growth on your savings as long as your money remains in your account.

Anyone can start one as soon as you begin earning an income and start filing a tax return. Your contribution amount is limited to 18% of your income, up to a maximum of $29,210, but if you contribute less than the maximum amount, you can carry forward unused contribution amounts to future years.

You can contribute to it over the course of your working life, and when you retire (or by the end of the year in which you turn 71), you can convert it to a Registered Retirement Income Fund (RRIF) and withdraw an income. You can also borrow from the account for two additional reasons.

  1. You can borrow up to $35k, tax free, to make a down payment on your first home. The amount you borrow must, however, be paid back in equal increments over 15 years.
  2. You can borrow up to $10k per year to pay for full-time education or training for you or your spouse. To avoid tax penalties, you must pay back these funds in equal increments over 10 years.

Withdrawals made before retirement for other reasons will be subject to taxation at your current tax rate, so it is not recommended unless absolutely necessary.

One more thing to keep in mind, you can contribute to your 2021 RRSP as late as March 1, 2022, so if you haven’t maximized it yet, you have a few more weeks to do so if you determine that is your best move.

Tax-Free Savings Account (TFSA)

Introduced in 2009, a TFSA is another tax-advantaged way to save. The account can hold cash as well as mutual funds, segregated funds, and other savings vehicles. Unlike a conventional savings account, you pay no tax on the interest, capital gains or dividends you earn. You can also pull tax-free money from this account when needed, unlike from a non-registered account.

The government does set annual contribution limits for TFSAs, (currently $6000) but if you contribute less than that amount, the unused portion carries forward each year. This means you can contribute more than the designated annual maximum in years following those with lower contributions. There are no limits on what the money can be used for, unlike RRSPs, and many people use a TFSA to supplement their RRSP retirement savings.

Which One Is Best for You?

Like all big questions in life, it depends on a variety of factors including what you want to save for (retirement or other large purchases?), how much money you will be able to contribute, and your marginal tax rate (MTR). Since both accounts offer tax-sheltered growth, it is ideal to maximize your contributions to both, when possible. But if that isn’t financially feasible, it pays to take a close look at your personal situation and goals, as well as how you want your retirement to look and how much money you expect to need at that time.

Keep in mind that the biggest difference is in how the money you contribute to these accounts is taxed. RRSPs offer a tax deduction when the money is put into the account, but you must pay tax when you take the money out. TFSAs do not provide an up-front tax break, but you do not pay tax on anything you withdraw, including the interest earned.

With that in mind, one way to choose which account to invest in is to compare your current marginal tax rate to what you expect it to be in retirement. If you pay a higher MTR now than you think you’ll pay later, investing more in an RRSP may be your best bet. If you expect to pay a higher rate in retirement than you do now, adding to your TFSA may make more sense. If you expect little change in your current and retirement MTR, you should consider contributing to both, even if you don’t maximize your annual contribution, since you can catch up on that in future years.

This is vastly simplifying the factors involved in making the best investment decision. Other things to consider in tandem include planned large expenditures, upcoming changes in your income and MTR, future impact on your CPP/QPP and OAS, and more. If you want help looking at your big picture for this year and the future, we are happy to help.