What Wins the Retirement Savings Battle: TFSAs or RSPs?

Daniel Steinkey |
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One debate that seems to come up over and over again in retirement savings discussions is which is the better investment: a tax-free savings account (TFSA) or retirement savings plan (RSP). And the simple answer is: there isn’t one. It’s a convoluted, and therefore annoying, answer. Let’s start with a reminder on what each plan does and them we’ll take a look at some factors to consider.

Tax Treatment of Each Plan

RSPs have been around the longest. You use income that hasn’t been taxed for your RSP investments. Instead of paying tax up front, you pay tax whenever you withdraw money (hopefully not until retirement). On the other side is TFSAs, which the government introduced in 2009. These plans work the opposite way. You invest money you’ve already paid income tax on, but you won’t ever have to pay tax on this money again, even if you make super gains in the plan.

Factors to consider

In an ideal world, everyone would maximize their contributions to both. Since that’s fantasyland for many of us, we have to prioritize. The first thing to consider is your marginal tax rate now, versus what you think your marginal tax rate will be in retirement when you withdraw your funds. If you are in a high tax bracket now and expect to be in a lower bracket once you retire, RSPs might make more sense. If you are in one of the lowest tax brackets now, you likely won’t be paying lower taxes in retirement, so you would be better off in a TFSA.

This seems easy enough, but there are caveats. One, you can’t be absolutely certain what tax bracket you will be in when you retire, especially if that’s decades out. The second big caveat is the effect your RSP can have on your Old Age Security payouts and possibly your Guaranteed Income Supplement (GIS) if you are considered low income in retirement.

If you have large payments coming out of your RIF (retirement income fund) in retirement, it counts as income. Your OAS payout could get clawed back, so you’d end up with less government money, meaning less money overall. Boo. Anything you withdraw from a TFSA does not affect your OAS or GIS payouts, so this is something to consider when you’re doing your investment math.

Finally, the theory of growing money tax free within your RSP also includes a step we often forget about: reinvesting the tax refund you get for making RSP contributions back intoyour RSP. How many of us do that? And how many of us spend our refunds on vacations, new toys or bills instead? If you aren’t reinvesting your tax refund into your RSP, your RSP won’t build quite as well as it could.

Bottom line

If you would like help figuring out if TFSAs or RSPs are the better option for you, I’d love to talk. We can have a scintillating discussion about tax brackets, OAS clawback and how to get you the most money in retirement.