Should I contribute to my RRSP or TFSA? It’s a common decision faced by thousands of Canadians each year. Ideally, we’d contribute the maximum to both. Unfortunately, life has a way of being expensive. Many of us have other financial priorities, including mortgage payments, car payments, child care expenses, contributing to our children’s RESP and the list goes on. This means that although we’d like to contribute to both RRSPs and TFSAs, we might only have enough to contribute to one.
So how do you choose the right one? Let’s take a closer look at RRSPs and TFSAs to help you figure out.
RRSP short for “Registered Retirement Savings Plan” is a tax-sheltered account primary used for saving toward retirement. If you have earned income (you have a job), you can contribute to the RRSP. You’re able to contribute 18 percent of your earned income in the last year or the RRSP limit, whichever is less (unless you’re earning six figures, it’s most likely 18 percent of your earned incomed). If you’re fortunate enough to have a pension at work, please be aware that your RRSP room will be reduced to account for it. This is to help level the playing field between the pension have’s and the pension have not’s.
When you put money inside your RRSP, you’ll get an immediate tax break. Also, any money you invest inside your RRSP will grow tax-free until it’s withdrawn.
You can hold a variety of investments inside your RRSP, including savings accounts, GICs, ETFs, index funds and mutual funds. To find out your RRSP contribution room, refer to your notice of assessment you get after you file your taxes.
TFSA is short for “Tax-Free Savings Account” and is the newer of the accounts. TFSA started in 2009 and have been popular with Canadians ever since. In fact, Canadians now contribute more money to TFSAs than RRSPs. Unlike the RRSP, you don’t need earned income to contribute to a TFSA. You just need to be above 18 years old.
TFSA contribution room isn’t based on how much you earn. Everyone receives the same annual contribution room. In 2019, the annual contribution limit is $6,000.
Unlike the RRSP, you don’t get a tax refund up front, but similar to the RRSP, your investments grow tax-free inside. However, where the TFSA has a leg up on the RRSP is that when you withdraw your investments, you don’t have to pay any income tax (you do with the RRSP). Your contribution room is also restored January 1st of the following year after a withdrawal.
Similar to RRSPs, TFSAs can hold a variety of investments, including savings account, GICs, ETFs, index funds and mutual funds.
Deciding Between the Two
A lot of articles like to overcomplicate matters in terms of whether you should contribute to the RRSP or TFSA. I like to keep things simple. If you’re earning less than $50,000, you’re generally better off contributing to the TFSA. If you’re earning more than $50,000, you’re generally better contributing to the RRSP.
Other things to consider are your income in retirement. If you’ll be earning more in retirement than during your working years, then the TFSA can make more sense than the RRSP, since being in a higher tax bracket in retirement can lead to claw backs of government benefits such as Old Age Security.
Likewise, if you aren’t going to be earning very much in retirement, contributing to your RRSP often doesn’t make sense, since it would result in Guaranteed Income Supplement being clawed back.
These are just some things to consider when choosing between the RRSP and TFSA. My best advice is to choose one and make regular contributions to it. By getting into this good habit, you’ll reap the rewards later on in life.
About the Author
Sean Cooper is the bestselling author of the book, Burn Your Mortgage: The Simple, Powerful Path to Financial Freedom for Canadians. He bought his first house when he was only 27 in Toronto and paid off his mortgage in just 3 years by age 30. An in-demand Personal Finance Journalist, Money Coach and Speaker, his articles and blogs have been featured in publications such as the Toronto Star, Globe and Mail, Financial Post and MoneySense. Connect with Sean on LinkedIn, Twitter, Facebook and Instagram.