RRSP Vs TFSA — How To Pick, Based On 5 Scenarios - ACM CPA

November 2024
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RRSPs and TFSAs are an investment tool you’re meant to put tens of thousands of dollars into for important life events. That also means that choosing between the two is pretty high stakes.When it comes to picking an investment strategy, a methodical and far-reaching approach is good. What’s better is tailoring your choices to fit your individual situation is crucial.To make a decision you’re confident in, consider the following scenarios and conclusions about when each investment strategy outweighs the other.

1. Earnings And Tax Brackets

The tax bracket you fall into is determined by your earnings, and it dictates the amount of income tax you’re required to pay back to the government. Hence, it plays a significant role in shaping the most suitable investment strategy for your situation.

As a general guideline, individuals earning over $50,000 annually will find it advantageous to invest in an RRSP. This is due to the tax deductibility of the contributed funds; basically, your taxable income will be reduced.

Conversely, for those with an annual income below $50,000, the value of this deduction is low. This is because after you factor in basic tax credits, the chances of owing a substantial amount of income tax are unlikely. In such scenarios, directing your funds toward a TFSA would be a more prudent choice. To assist you in determining how much tax you’ll pay, here’s a chart outlining the Canadian tax brackets:

Annual Income (Taxable)	Tax Brackets	Tax Rates	Maximum Taxes Per Bracket	Maximum Total Tax
Up to $49,020	The first $49,020	15%	$7,353	$7,353
$49,020 to $98,040	The next $49,020	20.5%	$10,049.10	$17,402.10 ($7,353 + $10,049.10)
$98,040 to $151,978	The next $53,938	26%	$14,023.88	$31,425.98 ($17,402.10 + $14,023.88
$151,978 to $216,511	The next $64,533	29%	$18,714.57	$50,140.55 ($31,425.98 + $18,714.57)
Over $216,511	Over $216,511	33%	n/a	n/a

To summarize:

If you make over $50,000 a year, invest in your RRSP.
If you make under $50,000 annually, build up your TFSA.

2. Timeframe And Goals

Whenever an investment opportunity arises, it’s wise to clearly define the purpose behind your savings. Planning for retirement generally involves a longer timeframe, especially to other financial goals like saving for your child’s education or funding a home improvement project.

Funds within your RRSP are designated for your retirement. This program is structured in a way that when you eventually withdraw the funds, your income will likely be lower, placing you in a reduced tax bracket. At that point, you’re paying lower taxes on your RRSP money than if you had paid as you earned it.

With an RRSP, you’re leaving your money in the bank until you reach a certain age. This arrangement serves its intended purpose effectively, but it doesn’t cater to short- or medium-term objectives. This is where a TFSA offers you more advantages, as withdrawals can be made without incurring taxes or penalties. Money invested in a TFSA can be easily accessed for purposes like purchasing a car, with no tax-related consequences.

To summarize:

For longer-term savings goals, like retirement, focus on your RRSP
For short- or medium-term savings goals, like an emergency fund, use a TFSA.

3. Employee RRSP Benefits

When your employer will match your RRSP contributions, the value of investing in your RRSP is significantly enhanced. Typically, employer contributions function in a way that aligns with your own investment, where your workplace matches a percentage of your salary as long as you contribute to your RRSP, sometimes even on a dollar-for-dollar basis. This additional contribution from your employer essentially presents a guaranteed return on your investment, a foolproof benefit that is simply unmatched by most other investment strategies.

Let’s delve a bit deeper into this concept. Imagine your employer offers a 2% match on a $70,000 income, resulting in an extra $1,400 contributed to your RRSP. Notably, your employer’s share of the contribution might also be considered for your RRSP deduction when calculating taxes. This dual advantage is likely to sway your preference towards an RRSP compared to other savings avenues unless the matching percentage is low or the available investment choices are subpar.

To summarize:

RRSPs are almost always superior investments if your contributions are matched by your employer; it’s literally free money.

4. First-Time Homebuyers And Continuing Education

It’s obvious by now that RRSPs are tailor-made for retirement planning. But they can help you achieve other big life goals as well. Consider the Home Buyers’ Plan and the Lifelong Learning Plan.

The Home Buyers’ Plan enables eligible individuals purchasing a home to withdraw a maximum of $35,000 from their RRSP for this purpose. This withdrawal is exempt from taxation and necessitates repayment within a span of 15 years. This provision is particularly advantageous for obtaining a substantial lump sum, such as a down payment, and although repayment is required, the borrowed amount operates without incurring interest.

Likewise, the Lifelong Learning Plan (LLP) is a program affording you the opportunity to utilize your RRSP savings for your own or your spouse’s full-time education or training, with a cap of $20,000 over two years. The obligated repayment of this sum is set within a timeframe of 10 years.

To summarize:

If you can capitalize on the Home Buyers’ Plan or the Lifelong Learning Plan, start working on your RRSP.

5. Already Retired

Withdrawals made from TFSAs are consistently exempt from taxation, regardless of whether you’re actively employed or retired. On the contrary, withdrawals from RRSPs are invariably subject to taxation.

During your retirement phase, it’s probable that you’ll fall into a lower tax bracket compared to your pre-retirement years. Therefore, withdrawals from your RRSP will be taxed at a reduced rate compared to the taxation applied when you initially contributed the funds.

Bonus tip: If you discover that you’re due for a tax refund, you can optimize its benefits by reinvesting the surplus into a TFSA.

To summarize:

Your TSFA will be more useful for withdrawing funds at zero tax.

Final Thoughts

Adopting a thoughtful and long-range approach to your financial decisions will yield significant advantages for you — and customizing these decisions to your unique circumstances is paramount.

With the guidance of a professional tax advisor to validate your choices and guide your process, you will reach the milestones you’re daydreaming of. Book a free consultation with us so we can listen to your long-term goals and make an actionable road map to get there.