It’s been a while since I shared a hilarious tale of the times I did the opposite of what standard financial advice – whether my own or someone else’s – would have recommended in that situation.
For reference, the things I’ve been an example of how NOT to do include choosing a credit card, buying car insurance and saving up an emergency fund. And now, with this post…
Drumroll please…
That list includes how not to choose between a TFSA and an RRSP.
(American friends, I think this is like choosing between an IRA and a 401K, but ¯\_(ツ)_/¯ ?)
There are two main reasons I wanted to share this story. One, yesterday marked the start of Financial Literacy Month, aka the personal finance high holidays, and while there are some stellar arguments about how financial literacy won’t save us – or make us save our money – there are definite benefits to knowing stuff about money.
One of the big “you should know stuff about this” topics is, of course, our tax-advantaged savings accounts, the RRSP and the TFSA.
Use them right, and you could save thousands of dollars in taxes every year, and set yourself up for a pretty sweet retirement. Use them wrong, and…
Well actually, that’s a perfect transition into my tale of how not to choose between a TFSA and an RRSP.
That Time I Didn’t Choose Between a TFSA and an RRSP
The best way to not choose between a TFSA and an RRSP is literally just not to choose.
I know, major letdown of a post, right?
But in all seriousness, that’s exactly what I did when I graduated university. As taught by my personal-finance-rockstar mom, I went straight to the bank during my first few weeks of full-time work, asked to open a retirement account, and when they asked which one, I literally said “One of each, please.”
I was polite, if poorly informed about how to choose a tax-advantaged account.
In the same meeting, I set up twice-monthly transfers to each account, putting exactly the same amount of money in each account. I also took my teeny savings, divided it by two, and put half in each of my shiny new tax-advantaged savings accounts (which, FYI, I could have started using while I was still a student if I had asked for them.)
You hear that faint sound?
It’s the sound of every accountant and tax specialist reading this quietly weeping for how bonkers-not-efficient my use of those accounts was when I graduated. Even looking back on it as a Total Tax Novice, I kind of cringe too.
But Was It Really That Bad A Move?
While no, I am 100% not recommending you just learn nothing about TFSAs and RRSPs, and put half of your total savings into each one while hoping for the best, I also don’t think it’s the worst thing you could do with your money.
Optimal? Not a chance, not even kind of.
But… it’s still saving.
I still got a tax refund for my RRSP contributions those years. I still got some paltry tax-free growth on my TFSA savings. And I still built up both balances to a respectable amount for a 20-something who hasn’t hit her peak earning years (well, hopefully anyways). It turns out, more than anything, regularly saving a bit of money every two weeks will do that to you.
So if you really, truly, absolutely cannot fathom learning anything at all about your TFSA and your RRSP, either pick one, or pick both, and just do it . I promise you the worst that will happen is that you will save money in an account that turns out not to have been the best-case tax scenario (but you still saved money, so you’re OK, I promise.)
The “Right” Ways to Choose Between a TFSA and an RRSP
Nowadays, I’ve got a bit better of a handle on my savings situation, and a (much) better understanding of the details of both the TFSA and the RRSP.
Even with all the details of each account, and the specific nuances of which one would be best for each individual human, I still find there are three questions you can ask that will take you a solid 80% of the way towards choosing the right tax-advantaged, long term savings account for you, for now.
Do you want to avoid any big hassles?
Go with the TFSA. Sure, you won’t get a tax refund, but your tax filing will be marginally simpler, you can withdraw the money if you need to, and you can always move money into an RRSP later if you want to. If you’re looking for the no-brainer, quick-start option, a TFSA is it.
Do you think you’ll need this money before retirement?
If you will, keep it in a TFSA. When you withdraw money from an RRSP, it’s considered part of your taxable income that year, and taxes will likely be withheld on withdrawal. That means that if you need to take out $10,000, you’ll probably only end up with about $7,000 give or take – unless you’re taking it out under the Home Buyer’s Plan or the Lifelong Learning Plan. So if you’ll need the money in the next few years for something other than your first house or a degree? Toss it into a TFSA.
However, unpopular opinion time: if you’re saving for retirement, I personally think not being able to withdraw the money easily is a pretty sweet feature. You’re talking to someone who raided her TFSA to buy a car in cash, which yes, was hella convenient, but also hella not great for my retirement savings.
Are you making more now than you think you’ll make in retirement?
This question is a good gage for how much you should focus on long-term saving within an RRSP, for the simple reason that you get a tax refund when you put money in, but you’re taxed on the money when it comes out. While some people think that makes the RRSP a scam, it’s actually just a deferred tax account (and no one complains when they get a sweet refund in April, amirite?)
If you’re making more now than you want to withdraw every year in retirement as income from your RRSP, you’ll save more on tax overall by contributing to an RRSP now. You can – and should – look into the details on that by researching your tax rate and planning your retirement spending, but if you’re not up for all that?
Make a best guess, start contributing, and adjust as you get more information.
Bonus fourth option: read this great flowchart from Holy Potato to help guide your decision even more.
Now, is that everything you need to know about TFSAs, RRSPs and how to choose between the two? No, of course not, because there are entire tax-planning courses and Very Informed Professionals who can give you detailed recommendations for your specific, nuanced situation.
But if you just want to make a good-enough-for-now decision so that you don’t waste another year not taking advantage of either the TFSA or the RRSP? You’ve got enough information.
Choose one now, ask more and better questions when you need to (or want to, you personal finance nerd, you!)
Do you have anything to add – including your own tales of figuring out the whole TFSA vs. RRSP thing, links to other resources, or advice for people going through it? Share them in the comments!
PS. Want a primer on the perks and nuances of each account? Check out the millennial’s guide to the TFSA and the millennial’s guide to the RRSP.
I don’t have any specifics to add since this American is a big ol’ NA for both of these. However, where I struggle the most is that IF I’m in teaching for the long haul, I will make significantly more in retirement than I do now…IF my state can fund my pension. There are exactly two more IFs in that sentence than I would like. So on one hand, I do think more people should be more information about retirement savings. But on the other, I totally get why it’s confusing and some people might opt out until they understand it better. Not the right thing to do by any stretch, but yeah.
Omg the retirement If List struggle is so real. And I don’t even have a pension I need to “if” about! There are just soooo many variables out there, that the best course of action (at least for me, in order to stay sane) is recognize what is in my power, learn about it and do that and …. hope for the best.
Lol this is why I’m not a financial planner!
One of the most interesting pieces of advice I was given to boost retirement savings was to take any tax refund and put it immediately back in to your RRSP. It was money that you weren’t really counting on anyway, so might as well compound that refund year after year… I, of course, have not followed that advice ever… but I would like to…
Hahaha I think a lot of people don’t follow that advice! And it’s tough, because that’s what makes the RRSP win – reinvesting your tax refund (at least the RRSP-related portion of it) to compound for the long term. Right now I’m a horrible example, because I’m using the RRSP tax refunds I get to help me save aggressively for a house, but my big plan is to reinvest them once I’ve got the house thing sorted! (So hopefully, next year!)
Not applicable American here. My understanding is that The TFSA is most like the Roth IRA, similar contribution limits and everything. A Roth 401(k) would be like a TFSA on steroids. If you did the Traditional IRA or Tradtional 401(k)…it’s kind of like the RRSP, but kind of not. The RRSP is sort of it’s own little animal. Looks like a $25k-ish max contribution limit but it can’t be more than 18% of income. In America, it’s an $18,000 max for the 401(k) (traditional, roth, or a combination of the two), but it doesn’t matter how much of your income,, so you could theoretically contribute 70% of your income if you wanted to / could afford to do that.
Thanks for the additional info, TJ! I figure I should get a really thorough grip on our own Ture North Tax Advantaged Accounts (made up name, obviously) before diving into really understanding the American equivalents, lol.
I’m lucky enough to be able to max out both, so that’s what I do. (I have a pension so my RRSP contribution is paltry, though.) I’m a little wary of the RRSP because my mother is coming up on her 71th birthday and annoyed that she’ll pay so much taxes/lose benefits on her RRSPs. (My father didn’t have a pension so he contributed a lot to his RRSP, and she inherited his share – so, 5% of the combined account is a lot.) I plan on funding my retirement pretty much through TFSAs alone though, since compound interest is (hopefully) going to work enough for me to do so. I usually recommend TFSAs first to my friends!
Totally! Especially if you have a pension, the TFSA is the way to go, since your pension will already put you in some kind of tax bracket when you’re retired (that’s what I tell all my government friends!). As someone who’s going to only have CCP and OAS, and likely “make” well under the $76K OAS clawback level in retirement, the RRSP isn’t quite as bad from a tax and loss-of-benefits perspective for me personally, but I definitely recognize that the tax implications are brutal if you end up with “too much” or more than you need in the RRSPs!
Mirielle
In response to your mother’s concerns. When your mom turns she needs to transfer her RRSP’s to a RRIF this enables her to draw only her minimum withdrawal and reduce her tax exposure. I learned that lesson when we had to transfer my mothers.
Hope this helps with her concerns.
Being a Canadian, I save in both RRSP and TFSA. My advice will be to invest any tax refund into TFSA. The other thing people usually says is if you have RRSP, you pension from government will get reduced. Then there are people who invest in life insurances and then borrow money from bank against the insurance. (Borrowed money is not earned income and you don’t have to pay tax on it). It is legal in Canada. I don’t know the details though. Being a low income earner, those kind of games are not worth for me.
If you are working to make your life, then Canada will get your tax either now or later. If everybody is finding loopholes to avoid paying taxes, we cannot have many of the services we enjoy in this country.
Very good points – and I agree, I have no problem paying my fair share of taxes because we really do enjoy so many wonderful government services here in Canada. Our healthcare alone makes me very grateful to be a Canadian!
Desirae the insurance policy Pellrider is talking about is only the Universal policy will do that. This is whole life insurance . I’ve since I bought mine learned it’s a good alternative for children’s education funds as this works there as well. They borrow the money from themselves and pay back themselves to reimburse their retirement.
I make it simple by maxing out both TFSA and RRSP. That means I also take advantages of all the benefits that TFSA and RRSP have to offer. Win win for me. 😀
Hahahaha definitely! That’s the real goal for sure – I like to console myself by reminding myself that I’m going to have so much built up RRSP contribution room by the time I get around to maxing it! (And if there’s ever an income event that I want to offset, like a bonus or equity event, I’ve got the room to take at least some of the tax hit out of it. Thanks, RRSP!)
Pellrider,
Your future Canada Pension Plan (if eligible) is NOT impacted in any way by RRSP contributions. OAS could theoretically be reduced if you had a very large RRSP and withdraw enough each year in retirement to be more than the $76K level that starts to see clawback. If you have enough saved in your RRSP to be withdrawing more than $76K/year in retirement, you probably have enough other assets that you already did not qualify for OAS.
^^^ What Jeff said!
Des,
I actually think your “non choice” might have been a good choice at that stage of life. While folks can do research to use these tool to minimize current and future tax, a simple way to think of it is RRSP is for retirement, TFSA is for medium term savings. Note that a TFSA is a bad name because it does not (and really should not) have to be a bank account. The TFSA can hold investments like stocks, bonds, GICs, mutual funds, etc.
While there are rules that let you borrow or withdraw from the RRSP for things other than retirement, I think it overall is a terrible idea to make those withdrawals. Odds are you will never make them up and you will pay for it in reduced retirement savings.
Every dollar that we intend to save for retirement goes into our RRSP and we will NOT touch it until then. If the RRSP is full and we need to save more (I have no pension and am in my peak earning years), I save in a separate non-registered account that I also tag as only for retirement.
Savings for things like new cars, houses, renovations, etc are all done really well in the TFSA. There is not tax implications to moving money in or out of the TFSA, the only thing it offers is you do not have to pay tax on any interest, dividends, or capital gains that the money makes in the TFSA.
Savings for education for minors should be done in a RESP — you get a government grant by doing so and it is also tax advantaged.
Most people should be targeting to max out their RRSP each year if possible (I know this doesn’t happen but it should). You can contribute 18% of your income less any company pension amount. If you are lucky to have a full pension, you probably will not be allowed to contribute much or anything to an RRSP. If you have no pension, you need to save enough to make up for the missing pension. A pension is worth ~12-18% of your pay…
Oh man, the “TFSA is not a savings account” post is going to be my rant next week! Although I can see the argument of using part of your contribution room to shelter things like your emergency fund or house savings IF you have room and can’t max it out with investments for longer-term goals. If EQ Bank offered a TFSA I’d have my cash emergency fund in there in a heartbeat!
And as usual, your recommendations are all totally on point – RESP is a no-brainer for saving for kids’ education, and I’m with you on team don’t-ever-withdraw-from-your-RRSP. There are so few people who use it strategically with the intent to save for a house within it, that the majority of people are just raiding money they had intended to save for retirement in order to buy a house. If you always planned that as your house savings, and you have been saving somewhere else for retirement? Awesome, go for gold, but I doubt many people do that! I also had someone tell me that if you withdraw using the HBP, the “money” keeps compounding in your account as you repay it. Like, THE FULL AMOUNT. That you just spent.
Nope, false. Do not pass go, you are doing it wrong.
Thanks for the detailed comment Jeff!
Desirae
The RESP offers the contributor only the grant money and investment vehicle.
When it comes time to cash it in the child pays the tax on the money as they receive it. Hopefully they only pull out what they need but if they pull it all at once it proves to be a hefty tax bill for them.
That’s why when I found about the Universal Life Insurance program it does provide a tax shelter as the contributions are already taxed money. You can borrow or use as collateral and repay and keep your insurance policy payments going for your future insurance needs.
That’s why I would only RESP enough to earn the maximum education grant money.
If you’re in your 20s (ish) and aren’t able to max out your TFSA, I would recommend focusing on the TFSA. Reason being, if you decide later on (even 6 months down the road) that you would have preferred it go into your RRSP, you can always make that switch, whereas you can’t go the other way without running into large penalties. Plus, if it’s a year, two years, or more later that you decide you would have preferred to put the money in the RRSP there’s a good chance you will be earning a higher income, and potentially have a larger return due to higher tax brackets.
You’ll need to have a bit of will power to not raid your TFSA, but as long as you’re able to do that I think it’s the better approach in the long run.
I love this logic Luke, and I totally agree! There’s really only one way to switch accounts easily, and it’s from a TFSA to an RRSP.
Now, the willpower thing, lol. (I admit it’s gotten easier as I’ve had more time – and money – to save towards specific goals!)
Luke you would never transfer the money from TFSA into the RRSP. Just start your RRSP and carry on.
I really appreciate the explanations Jeff gave me. Now I can happily save money in my RRSP and enjoy the refunds if any.