RRSPs vs TFSA: Which is more effective in enhancing my retirement income?

As you plan for your retirement, you may be wondering about the best way to make your money work for you. You’re making great headway with your pension, but may be curious as to whether other personal savings options like Tax Free Savings Accounts (TFSAs) and Registered Retirement Savings Plans (RRSPs) could help add to your retirement income. The quick answer is yes —but there are important factors to consider when deciding between the two.

Are your savings goals long-term or short-term? When will you want to withdraw funds? What are your current and projected retirement income and tax levels? If your PSPP pension is the anchor of your retirement income, RRSPs and TFSAs are savings vehicles that can provide additional retirement income depending on your retirement goals. Our Client Service Advisors are Certified Financial Planners®, and are able to help you navigate key decisions that affect your pension and overall financial health. If you’re considering a TFSA or an RRSP, let Renée Verret — one of our Advisors — give you some helpful information.

Key differences and similarities

There are notable differences and similarities between TSFAs and RRSPs. “The goal of an RRSP is long- term, generally used to provide supplemental retirement income,” says Verret. “A TFSA can be used for short, medium, or long-term goals as the account is multi- purpose.”

Also important to note is that for 2020, the annual limit for RRSP contributions is 18% of your previous year’s annual income, to a maximum limit of $27,230, minus your pension adjustment (PA), where the annual limit for TFSA contributions is set each year by the Federal government. For 2020, the TFSA contribution limit is $6,000.

There are some similarities. Both:

• Can be used as forced savings plans that can be set up with automatic contributions
• Can hold investment products such as equities, bonds, exchange traded funds (ETFs), or mutual funds
• Allow you to carry forward previously unused contribution room

Contributions

Contributions to your RRSP may generate a tax refund or lower the amount you pay because these contributions are tax deductible. With a TFSA on the other hand, while your contributions are not tax deductible, your investment income is not taxed. The higher your income the more attractive the RRSP is, as you contribute at a higher marginal tax rate while working and you —likely — withdraw at a lower marginal tax rate when retired. This is when the product works best.

Conversely, if your tax rate while working will be similar to when you are retired, the RRSP won’t be as beneficial to you. In that case, a TFSA would work well. To help you figure out which savings solution best supports your long-term financial planning strategies, you can contact one of our Advisors to discuss your options.

Withdrawing

Withdrawing from your RRSP before retirement is a decision that shouldn’t be taken lightly, as RRSPs should be considered a longer-term strategy aimed at helping you save and grow your retirement savings. “Withdrawing income from your RRSP before retirement is not recommended as it always attracts tax,” advises Verret. Investments may have to be sold, which could result in fees — and you’ll lose that RRSP contribution room permanently.

Withholding tax rates for RRSP withdrawals are:

• up to $5,000: 10% tax,
• between $5001 and $15,000: 20% tax, and
• greater than $15,001: 30% tax

“Any RRSP withdrawals are added to your income in the year received,” adds Verret. “If you are a high income earner, such as with a salary of $100,000, you will owe more tax on the RRSP withdrawal when you file your taxes, as your marginal tax rate on the next dollar earned at that income level is 43.41%.”

“There are no penalties for withdrawing funds from your TFSA. There are no taxes to pay, nothing is withheld at source, and you do not lose the contribution room — in fact, you regain that contribution room the following year. This is why the TFSA is a great account for short term goals.”

Pension Adjustments

As members of a Defined Benefit (DB) pension plan, you will receive a pension adjustment (PA) on your annual T4 that reduces your RRSP contribution room for the following year. This limits the amount of RRSP contributions DB plan members can make over and above their pension contributions.

For TFSAs, there is no reduction to your annual limit neither pension contributions nor RRSP contributions affect TFSA contribution room. If you will be opening a TFSA for the first time in 2020 and you turned 18 in 2009 or earlier, you will have the maximum $69,500 in contribution room.

Which is best for you?

There’s a lot to consider when deciding whether an RRSP or TFSA is best for your scenario.

Personal tax rates are important both while working and in retirement. If you’re in a high marginal tax rate with a spouse in a lower tax bracket and you anticipate a large pension, making your annual RRSP contribution to a spousal plan will allow you to receive the tax deduction while your spouse can draw the income in retirement. Alternatively, you can maximize your TFSA and draw supplemental income in retirement that attracts no tax.

Your goals also play an important role in which product you choose and, usually, a mix of both TFSAs and RRSPs is ideal. Here are some common savings goals and which product is the best option:

• Home renovations — TFSA
• Vacation — TFSA
• Supplemental retirement income — either one, depending on the annual target and duration of income stream
• Down payment on a home — either one, but the RRSP will allow you to use the Home Buyer’s Plan

Understanding the benefits and limitations of RRSPs and TFSAs is crucial for a solid savings plan, no matter which one you choose. Seek out resources, ask questions, and make informed decisions — and remember, our Client Service Advisors are available to help you! Advisory services are offered at no cost to PSPP members over the phone or via a video call. To book a one-on-one session, log in to your e-services account at the top-right corner of our website and select ‘Book My 1-on-1’.