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RRSP vs TFSA: Which is better for retirees?

Published on: November 30th, 2020

If you are trying to decide which is better for your retirement income, the Registered Retirement Savings Plan (RRSP) or Tax-Free Savings Account (TFSA), you won’t find a simple answer. RRSP versus TFSA decision is a complex question and many people find the answer ends up being both.   

First step is to identify your objectives

Since an RRSP is designed for retirement income, we’re investing money into the RRSP without paying taxes the year we invest that money, deferring the taxes until withdrawals in another tax year. This makes it very important to identify short-term, medium-term and long-term goals in your Retirement Income Strategy.

The investment in an RRSP when your income is higher during working years and deferring the taxes until a future lower taxable income year can make sense. This could mean you are paying less tax on that future income. Remembering that the money invested in the RRSP will be taxable on withdrawal and could come into question as whether the RRSP is an advantage for someone with a larger defined pension income during retirement. That may be the easiest RRSP versus TFSA answer is when the taxable income in retirement will not be much lower than working years. The TFSA may be the easy winner for that person or couple.

Creating tax-free income in retirement

Within your Retirement Income Strategy, you may wish to have some tax-free income.  The Canada Pension Plan and Old Age Security are taxable income sources for you in retirement.  Taxable income also comes from a company pension or rental income. The RRSP or Registered Retirement Income Fund (RRIF) withdrawals are also taxable income in the year withdrawn. 

So, if you have invested in your TFSA then in retirement you can create an income from that TFSA that would show up at tax-free income because it is not added to your tax return. 

To Recap:

  • An RRSP comes out ahead when your tax bracket is higher upon contributing and lower when withdrawing.
  • A TFSA wins out when your tax bracket is about the same upon contributing as in retirement.

It’s important to note that the above comparisons are general, and your Retirement Income Strategy will be the best reference to decide where to invest. Also note that some guesswork is involved, as you need to forecast your marginal tax rate in retirement. All of this is a process we can do together.  

Three effective strategies

Hedge your bets. Deciding between a TFSA and an RRSP is a challenge if there is difficulty forecasting your tax bracket during retirement. A solution is to hedge your bets – simply divide your annual contributions between a TFSA and an RRSP.

Focus on the end goal. You can invest in a TFSA during years you have lower income, then switch to RRSP contributions when you have a higher annual income.  In some cases, an individual may wish to redeem TFSA assets, contribute those funds to an RRSP, and then put the tax refund back into their TFSA.

Debt reduction. Another consideration for many is the idea of debts vs. TFSA. This is a consideration when deciding if paying off a debt is better than investing in a TFSA. Back to the overall Retirement Income Strategy as your guide. Many people will look at the after-tax rate of interest they are paying to determine if paying down the debt is a better strategy than investing in TFSAs. If you want guidance in choosing between a TFSA or RRSP, please consult us. We’ll compare options for you and discuss other personal factors that may affect your decision.

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