Are RRSP for the Rich and TFSA for the Poor?

So with RRSP season in full swing and you seeing a least five ads a day to contribute to an RRSP I thought I would point an often forgotten fact about RRSP: do you need one at all? This isn’t to say I suggest you avoid saving something for your retirement, but rather I question who should be investing in what type of account.

In some regards the RRSP program has always been for the rich or upper middle class.  As they are the ones getting the most tax savings and most benefit out of the program.  After all as you income increases you don’t have to keep spending the extra money, so in becomes easier to save a larger percent of your salary.

As an example, let’s say someone in Saskatchewan is currently earning over $100,000/year.  Yet their basic expenses for a family of four are about $35,000 a year.  So to max out their RRSP contribution of 18% of last years income ($18,000), it is fairly easy for them.  Also they get a tax savings of almost 40% when they contribute to an RRSP, yet when they take those RRSP out in retirement they likely will be in a 26% tax bracket so they will be doing very well with tax savings.

Yet in someone else is earning only $40,000 the RRSP program starts to become less useful.  After all their living expenses are likely also around $35,000 to raise their family, so saving 18% of their income ($7200) is going to be fairly damn impossible without cutting back on  their spending.  Add in the fact the tax savings is only 26% now and even when they pull the money out of their RRSP in retirement, as they will likely still be in the same tax bracket.

So what is a lower income person to do? Simple, skip the RRSP and go straight to the TFSA instead.  While tax sheltering only $5000/year for someone earning $100,000 a year isn’t that much (5%), for lower income people of about $40,000 it starts to be a decent percentage of income (12.5%).  While you won’t be getting a tax refund for TFSA contribution that is ok.  Why?  People tend to forget something key about RRSP’s, you have to pay tax on any investment gains you make over the years when you pull that money out.  You don’t pay tax now, but you still owe it in the end.  Meanwhile the TFSA tax shelters those investment gains forever (as you don’t pay tax on a withdrawal from a TFSA).

So when should you use an RRSP? You should use an RRSP to lower your taxable income into the lowest tax bracket.  After that any extra savings should go to the TFSA.  So for example, if your lowest tax bracket ends at $42,000 a year and you earned $45,000 a year.  Put the first $3000 of your savings into an RRSP to get the tax refund.  Then put any additional savings into your TFSA.

So during this RRSP season I would suggest you invest something, but depending on your income don’t assume it should be an RRSP.

9 thoughts on “Are RRSP for the Rich and TFSA for the Poor?”

  1. I love the TFSA, and I plan to max it out before I contribute too my RRSP. I still want to drop a tax bracket but I also want to make sure that I am always using the TFSA for all it is worth. My TFSA figures to be my biggest retirement account, while the RRSP is simply to reduce taxes and also for a bit of an retirement income boost when I am 65.

  2. Excellent advice! This is pretty well what he have planned to do. It is nice to have the RRSP/TFSA debate so clearly explained. Recently I’ve heard people stronly recommend one over the other but when I’ve challenged them as to why (if someone has a better way to use their money than me- I want to know about it!) they generally aren’t able to explain it. They are just repeating advice they’ve been given. The RRSP/TFSA debate is going to be different for everyone depending on their current income/ retirement plans/ whether or not they have a pension etc. To give a blanket statement is just silly.

  3. We follow this plan for the most part also. Since my husband is in the highest tax bracket, he contributes to my spousal RRSP only enough to get down a tax bracket. His RRSP got way ahead of mine thanks to a severance package a few years ago. Once we’re balance up again, he’ll make half of his contribution to each plan. Next, we contribute fully to our TFSAs. When that’s done we contribute a minimum of $12k/yr to extra mortgage payments. When that’s done we debate whether to go back to more RRSPs or more mortgage payments. Usually we make those extra weekly contributions based on the markets – if the markets are up we hit the mortgage, if the markets are having a sale…we sent the extra to our RRSPs.

  4. Great explanation!

    Like you said, you either pay tax on your money now, or when you are retired. The way I look at it, I would rather pay tax on it now, while I am working, than later when I am living on a reduced income.

    Don’t get me wrong, I contribute to both, but I contribute to my TFSA first, and my RRSP second.

  5. I always max out my TFSA before my RRSP, for the reasons you’ve outlined. I plan to be in a higher tax bracket when I’m retired. I can’t wait until the finance minister boosts the TFSA contribution limit. I predict it will be $5,500 within the next couple of years.

  6. Gordon Pape lays this out very nicely in his “Ultimate Guide to the TFSA”. I think this one should be required reading for all Grade 12 students. Anyway; while working, I brought in around $70k, my wife $12k. We maxed out RRSP contributions, and then TFSAs. Both of them got maxed though. Now that we are retired, we each make roughly $15k, and cannot afford to make any contributions, so we are slowly removing RRSP savings and maxing out our TFSAs. It will take us a long time to get them moved over, but we are paying the taxes slowly, and at the lowest tax bracket. The strategy is costing us the ability to make money on taxes we owe(RRSP), however, the access and versatility of the TFSA over the RRSP is unmatched, and we are willing to take a small hit for that. Besides that, if our RRSPs ever got big enough so that the rules of removing it after age 71 were to put us in the next tax bracket, we would lose, and that is a very real possibility. Not to mention the difference if I make a killing in a particular stock, such as AQN which has almost tripled since I bought it, in the RRSP I get nailed for the taxes on the gains, in the TFSA, the gain is all mine.

  7. Good common sense advice. You are exactly on my wavelength. The tax bracket issue is the key for the planning. RRSp are not for the people in the lowest tax bracket. Makes no sense for them.

  8. Good article and I think you’ve covered most of the RRSP vs TFSA issues. One thing most people don’t consider is RRSP vs unregistered investing. The BIGGEST benefit of RRSP’s is that you get a deduction at today’s tax rates (when you are a high income earner) and eventually get taxed at a future lower tax rate when you are a lower income earner and in a lower tax bracket. So I think your advice to invest in RRSP’s to get to the LOWEST tax bracket is not good. At most, people should invest to get to the lowest bracket they think they will be at in retirement when they are withdrawing funds.

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