Since the introduction of TFSAs, I am often asked if it still makes sense to contribute to an RRSP. My answer is, that it depends on each individual’s personal situation and financial objectives, as to which plan, or combination of plans, makes the most sense for their needs.
Let’s do a quick review of both plans. RRSP contributions are tax deductible. Any RRSP withdrawals are taxable as income and may impact one’s eligibility for federal income-tested benefits or tax credits. Withdrawals from an RRSP are final, and that contribution room is lost and cannot be reinvested back into your RRSP. Unused annual contribution room for both RRSPs and TFSAs is carried forward and can be caught up in the future if funds become available.
TFSA contributions are made with after tax income, so both contributions and earnings can be withdrawn tax free at any time. Withdrawals have no impact on eligibility for federal income-tested benefits or tax credits, which is a bonus for seniors.
RRSPs were designed to build long-term savings for retirement, whereas TFSAs can be used for both short and long-term savings needs. Any withdrawals from your TFSA can be added back in the following calendar year. This is a significant benefit if you’re saving for mid-sized to large purchases such as a vehicle or down payment on a home.
A TFSA may make more sense than an RRSP if you’re in a low tax bracket, since TFSA withdrawals have no impact on federal income tested benefits and tax credits such as the child tax benefits and Old Age Security.
If you are in a higher tax bracket, you might consider using both types of plans. For instance the RRSP may be a better option if it offsets more taxable income when contributing than when you start to withdraw your savings. In other words you get a greater tax deduction on your contributions but will pay a lower tax rate on withdrawals in the future. If the reverse might be true in your situation, a TFSA may be a better option.
So what to do? Whether to save in a TFSA, an RRSP, or both ultimately depends on your individual savings needs, your eligibility for income-tested benefits and your current and future financial situation and income level. I think that anyone with savings outside of an RRSP should consider using a TFSA first.
Last but not least, talk to a trusted advisor, as they can help you to determine what amounts you need to save to achieve your goals, and investments that are appropriate for your time horizon and risk tolerance. Take advantage of the best mix of tax-advantaged investment options available to Canadians.