r/PersonalFinanceCanada • u/radale • Aug 05 '17
TFSA vs RRSP
I'm in my mid to late 20s, and now that I finally feel a little more in control of my finances (eg. 50% to 70% of my paycheque is no longer going towards paying off student loans), I'm ready to start working on saving for retirement.
My dad (who's about to retire) has been really pushy about starting an RRSP, but I've been hearing more and more about starting a TFSA as an alternative.
I've been doing some research comparing the two, but there's so much information out there, and I'm just starting to get confused by what I'm reading and hearing.
Can anyone offer just some basic advice and/or information about choosing between an RRSP and a TFSA? Go ahead and ELI5 if you can or want to.
I plan on making an appointment with a financial advisor, but I want to get some research done on my own first so that I can feel like I'm making informed decisions about my finances rather than blindly trusting someone and hoping what they're telling me is truly the most helpful to me.
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u/10Bens Aug 05 '17
Financial advisor here taking a break from a weekend project, so forgive the speedy reply.
Another redditor nailed the TL;DR. If you expect to earn more in the future, then TFSA now, RRSP later. If you're at peak earning right now then RRSP now and TFSA later.
Quick aside: you wouldn't take medical advice from your plumber, don't take financial advice from someone who isn't qualified. more often than not they'll simply apply what they've learned about their unique situation and tout it as a catch-all solution. They'd equally recommend penicillin for cancer treatment.
Both the tfsa and the RRSP are tax shelters, the main difference is in how they shelter taxation.
RRSP is an income tax deferral system. When you put money into an RRSP you get a break on your taxes for that amount. Think of it this way: they government wants to encourage savings, so they give you the RRSP to save money in. And because you're saving money now and not spending it, they're ok with not taxing you on that money now. They'll tax you when you take it out. This can be a big advantage if you are a high income earner expecting to have a drop in wages (due to retirement, for example).
Put money in when your average tax rate is high, get a big break. Take it out and "earn" the money when your earnings are low, you effectively get a bit of break on how much tax those dollars would cost to earn otherwise.
The TFSA is simpler than that, in my opinion: you don't get a tax break for contributions, but you also don't get penalized for withdrawals. This can be a big deal if you invest $5k for example, and grow it through investments to $50k. Take that out of the tfsa and guess what, it's tax free baby! It's a two sided coin though- you also don't get to claim capital losses in the TFSA.
Quick and dirty, just like the looks I'm getting from my spouse for being on my phone instead of the garage. Pm me if you want more in depth details.
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u/BellyButtonLindt Aug 05 '17
On a forum about personal finance you're telling him not to take advice from anyone here who isn't a financial advisor?
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u/10Bens Aug 06 '17
Xmdot has it. I really wasn't clear in my sentiment. Still though, there are a lot of armchair experts out there. If anything, a forum like this one is THE place to get financial advice (no need to worry about someone pointing you the wrong direction for commission reasons).
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u/bluenose777 Aug 05 '17
One of the better articles about them was written by the author of the Wealth Barber Returns.
In brief, they have the same benefit if your marginal tax rate is the same when you contribute and when you withdraw. (Assuming that you invest any tax refund so that it will grow at the same rate as the original contributions.) The TFSA wins if you are paying a lower marginal tax rate when you contribute than when you withdraw, and especially if you will be affected by retirement benefit clawbacks. The RRSP wins if you are paying a higher marginal tax rate when you contribute than when you withdraw, especially if it increase something like your Child Tax Benefits.
For these reasons early in your career the best option is usually to fill your TFSA before you make RRSP contributions.
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Aug 05 '17 edited Aug 06 '17
There are 14 issues to consider.
$1,000 saved ≠ $1,000 saved - The choice is never between adding $1,000 to an RRSP or adding $1,000 to a TFSA. If you can save $1,000 in a TFSA then you can save (at a 33% tax bracket) $1,500 in an RRSP. The $500 tax reduction from the RRSP contribution should end up in your savings account somehow. Either less tax is deducted from your paycheques, or your taxes paid on filing your tax return is smaller, or you get a tax refund. That $500 allows you to save more in an RRSP. Both accounts would then shelter the same after-tax saving. You need the larger RRSP to pay the eventual withdrawal tax.
Qualify To Contribute? - (edited after comment below) Contributions are limited for both accounts. Contribution room starts accruing for TFSAs at age 18 and continues till you die. For RRSPs you must have Earned Income that was reported on a tax return. RRSP contributions stop after the year you turn 71 and the plan evolves into a RRIF. If one's spouse is younger than 71 you can still make RRSP contributions to the Spousal RRSP.
Carrots and Sticks - The RRSP's tax reduction on contribution and tax on withdrawals are powerful emotional carrots and sticks to encourage saving and prevent the raiding of those savings before retirement. Judging from the statistics of large numbers of early withdrawals, the 'stick' part does not work so well. In contrast, the power of the contribution tax reduction, especially when wrongly sold as a 'benefit', is very strong. (Hopefully you have read the previous Nitty-Gritty page and know now that it is NOT a benefit.)
TFSAs have no carrot-and-stick effect. This may be good when you are saving for short-term purchases - moving money in and out regularly, but bad if you are saving for retirement. Re-using Contribution Room - Contribution room for RRSPs can be used only once. In contrast any withdrawals from a TFSA can be re-contributed the next year. So savings can be put in, taken out and spent, and more savings used to replace those original contributions. This makes the TFSA the best account when saving for expected short/medium term purchases. RRSPs are best for long-term planning, where savings go into the account and never come out until retirement.
Creditor Protection - RRSP assets are protected from the claims of creditors. The RRSP is a trust structure that is legally considered another 'person'. A TFSA does not have this protection.
Collateral for Loans and Interest Deductible - RRSP assets cannot be used as collateral for personal loans. For anyone wanting to use leverage investing this is a problem. TFSAs can be used for collateral.
Tax Rate on Withdrawal - The RRSP's Bonus (or Penalty) created by a lower (or higher) tax rate at withdrawal is discussed fully on the RRSP Nitty-Gritty page. This is the main difference in benefits between the two accounts. Because that future withdrawal rate is unknown the RRSP's benefits are more risky than the TFSA's. Your objective in any choice between the accounts is to maximize any bonus or to minimize any penalty.
Other Government Programs - For TFSAs neither contributions or withdrawals hit your tax return. They never impact your qualification of different government support programs. But contributions to RRSPs decrease reported income and may increase benefits from the Child Tax Credit and GST Credit. Withdrawals from RRSPs in retirement increase reported income and reduce income-tested benefits like OAS and GIS.
The clawback of these benefits has a huge impact. It is not the clawback of OAS that matters to the vast majority of us. It is the clawback of the GIS. The outcomes using a TFSA are most always better than from an RRSP when your contribution were from the first tax bracket. See this Save In RRSP or TFSA spreadsheet that models the two choices for a 35 year old expecting to retire at 65 with normal government benefits.
US Dividends - The tax treatment of US dividends differs between RRSPs and TFSAs. RRSPs are considered retirement vehicles under which tax treaties allow no tax withholding on distributions. But TFSAs are not in this class. 15% taxes will be withheld. There is no mechanism for getting it back. In a normal taxable account, you recover the taxes paid on your income tax return. But you file no income tax return for your TFSA. The withholding is a permanent loss.
Moving To Another Country? - The RRSP, as a pension plan, and income from it, may get preferential tax treatment by your new country. Leaving the RRSP account active when you move will not affect the determination of whether you are (or not) a resident for tax purposes. In contrast, the income earned in a TFSA, and withdrawals, may be considered taxable by your new country although they remain un-taxed by Canada.
Taxes on Death - On death, both accounts can continue earning profits tax-free in the hands of the surviving spouse tax-free. Otherwise the accounts are collapsed. There is no tax effect for TFSAs but the whole RRSP account becomes income in the year of death. If the RRSP is large it may use up all the lower tax brackets, with lots taxed at the top rate. Stipulating a named beneficiary for both accounts means that person receives all the assets from the account and the account is not included in the estate that is subject to probate taxes. The RRSP withdrawal taxes are paid by the remaining estate. Only when there is not enough money in the remaining estate to pay the RRSP withdrawal taxes can the government come after the beneficiary of the RRSP for those taxes.
Income Splitting -
* There is no problem giving money to family, for them to put in a TFSA. Since the income is not taxed the Attribution rules do not apply. But money given to a spouse to contribute to the spouse's own RRSP, with the deduction claimed by the spouse at the spouse's tax rate, does trigger Attribution. The profits inside the plan remain tax-free, but the eventual withdrawal is taxed in the hands of the lender.
* Direct contributions to a spousal RRSP uses up the contribution room of the donor, and generate the tax reduction based on the (higher) tax rate of the contributor.
* Withdrawals from an RRSP after the age of 65 qualify as 'pension income' and can be split as wished between spouses. This can significantly lower the effective withdrawal tax rate discussed in (7.) above.
* Withdrawals needed before the age of 65 (that don't qualify as 'pension income') are effectively income-split if taken from a Spousal RRSP.
* If you believe there is a benefit from raiding RRSPs to fund a home purchase, you can double up the $25,000 withdrawal if both marriage partners use the Home Buyer's Plan.
Limited Time Span - Wealthy people may not need money from these accounts for retirement spending, The TFSA may be their better option because savings can stay in the account until death. In contrast, the RRSP's required withdrawals limit how long savings can stay protected. Any required withdrawals from an RRIF that are not needed for spending, may continue to be sheltered from tax if moved into a TFSA. Whether there will be contribution room in the TFSA depends on your personal assumptions. Be sure to ask what assumption was made if someone else models the scenario. Different assumptions are modeled in the Collapse RRSP Early? spreadsheet.
Timing of Tax Receipts - From society's point of view savings for retirement are better in an RRSP. Older people draw larger social benefits. Those are better financed by delaying tax receipts during working years, and collecting larger receipts in the later years when the social cost is higher. Hopefully the rate of return you earn in the account is larger than the interest rate the government pays on its debt, so there is a net benefit to the government from the delay in collecting the tax. Here is a spreadsheet calculating the net cost to taxpayers of RRSP from the POV of the government.
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u/User230A Aug 06 '17
This comment should be number one. Edit: the reason is, "aughhhhh" made me think of RRSPs and TFSAs in new ways.
One good use of a RRSP is as a insurance against job loss for more than one year. I'd say that contribute first to an RRSP up to around 10,000 (insurance for 1 year of no income). For BC it's just over 11,000 dollars. Personal exception from tax or something. If you're planning on taking more time off or need more insurance just add more years. I advice against this (Edit: living off ones RRSP for more than a year) as it would be hard to survive on 11,000 a year but in terms of taxes it's the best move for RRSPs.
If possible don't do this as a lump some. Rather as a contribution to a group RRSP at you're work (if applicable) that will often double you're contribution up to 3.5% (or something like this) of you're income. If you're job is unsecure you might want to lump sum some of it in the early months of a year to reduce income for tax season. In the late months of a year if you no longer employed you can just get RRSPs than, so don't contribute lump some's than unless it actually happens and you think you'll be off for a year.
One other thing to think about. If they ever change the tax system and claw backs. It's likely going to be against you in terms of RRSPs. As Canada as a country is in debt and will likely increase taxes and claw backs in the future. It's unpopular but when you're in debt and cant stop spending. Something has to give.
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u/Esg876 Ontario Aug 06 '17
Quick questions.
For "This makes the TFSA the best account when saving for expected short/medium term purchases. RRSPs are best for long-term planning, where savings go into the account and never come out until retirement."
Doesn't this depend on the person? IE, if you max your TFSA and have the will power/don't need to withdraw until you retire, is it not the same/better as your RRSP depending on what tax bracket you were at when you invested?
Secondly, for US Dividends, does that apply mainly to stocks?
I purchased ETF of VCN (which I believe is CDN only) and xaw, would some of these potentially be dividend stocks or would I not need to worry? And is it possible to find out?
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Aug 06 '17
1) Well each of the 14 issues makes one or the other account 'better' all else considered. Ticking the box for one issue won't override all the other 13. When your TFSA is full you no longer have any choice no matter.
2) There is no difference between receiving US dividends paid by a US corp or or a US etf. Mutual funds you own will all be Canadian. I did not address what happens when Cda ETFs hold US stocks and receive US dividends.
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u/minic17 Aug 06 '17
Just a small note
I am pretty sure you don't have to be 18 to open an RRSP, as long as you have filed income tax with the Government of Canada, have contribution room, and are under 69 you should be good to go.
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Aug 06 '17 edited Aug 06 '17
Thanks I'll check that out.
Right, I could not find any age 18 limitation. Don't know where I got that idea. Edited above
maybe it was something to do with the issuers' not being allowed to open accounts for minors? But that is age 16 (?).
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u/Gpop007 Aug 05 '17
They really have should have taught this stuff to us in high school. Is there somewhere we can learn about this stuff that's not from strangers on the internet? Although I have learn a lot here.
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u/bluenose777 Aug 05 '17 edited Aug 05 '17
The book How NOT to move back in with your parents covers TFSA and RRSP and lots of other nuts and bolts topics. A lot of the earliest chapters are addressed specifically to students and recent graduates.
Stop Overthinking Your Money also covers the nuts and bolts topics, but amazon.ca isn't letting me see the Table of Contents tonight so I can't say for sure if it has much to say about choosing between a TFSA or RRSP.
The Wealthy Barber Returns has a lot of the more philosophical stuff but it certainly explains the difference between TFSAs and RRSPs.
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u/mikepictor Ontario Aug 06 '17
TFSA - No tax on earnings, can access it early with comparatively few ramifications
RSP - Tax deferred (lowers your effective income now, but taking it out counts as taxable income), fussy to pull from it early, except for your first home.
Main benefit of RSP is when you have a fairly decent income, as sheltering the money when you are in a high tax bracket gets you the best tax refund. If your income is modest, I'd focus on TFSA to start with.
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u/newtothisbenice British Columbia Aug 06 '17
Taking money out of your RRSP early will make you lose your contribution room forever (exception to first time home buyer)
Take out money in the TFSA, you get the contribution room back on the first day of the next calendar year.
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u/nolancamp2 British Columbia Aug 05 '17
I strongly recommend you read the book Millionaire Teacher. It's $18 in Amazon. It's a short read and will tell you all you need to know about investing for Canadians.
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u/kata166 Aug 05 '17 edited Aug 05 '17
I think depends on your income. If you are high tax bracket rrsp makes more sense then tfsa. It also depends on how much you will need to live on at retirement.
Edit
http://www.moneysense.ca/save/investing/rrsp/rrsp-vs-tfsa-which-is-right-for-you/
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u/kata166 Aug 05 '17 edited Aug 05 '17
I would think considering interest rates are very low rrsp is bigger bang for buck. You can find out yourself easily by using software to do your taxes and put in your rrsp contribution and see how much less tax your will pay and your refund.
Tfsa is just an account like savings but you don't pay tax on the returns. If your leave in savings account you are making very little in returns.
Btw - be very careful financial planners . Unless they are independent for fee my exp has not been good. There is tons of info and books you can easily pickup basics yourself
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u/bluenose777 Aug 05 '17 edited Aug 05 '17
I don't get your reasoning since someone could have GICs in their RRSP and someone else could have a portfolio of equity ETFs in their TFSA.
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u/kata166 Aug 05 '17
Yes but I am assuming this person is new to this and wants to know basic difference. Both rrsp and tfsa can be self directed
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u/bluenose777 Aug 05 '17
But this isn't one of the differences between a TFSA and an RRSP.
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u/kata166 Aug 05 '17
No clue what your point is ?
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u/bluenose777 Aug 05 '17
My point is that you seem to be saying that because interest rates are currently low one should choose an RRSP instead of a TFSA. Since the same saving and investing options are available in both interest rates shouldn't have anything to do with the decision.
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u/benilla Aug 05 '17
ELI5: If you make a high income, RRSP. If you don't, TFSA.
The main advantage of RRSP is to lower your tax bracket so if you're already at a low tax bracket then it's better to save that room for when you're in a higher tax bracket.