TFSA vs RRSP – The Age-Old Question

Author: Julia Friesen ASA, ACIA – Financial Advisor

“Should I invest in an RRSP or a TFSA?”

This is a common question we are asked by clients. Some feel that RRSPs have gained a reputation of being worse for taxes in the longer term than a TFSA would be. Is this reputation justified?

The most common way to answer this question is to ask: “Will I be in a higher or lower tax bracket than I am now when I retire?” This question is met with the common answer “If you’re in a higher tax backet now than you will be in retirement – contribute to your RRSP. If not, contribute to your TFSA.”

While this is a good rule of thumb, there are other factors to consider.

Let’s explore two scenarios. The first is where you expect to be in the same tax bracket in retirement and the second is where you expect to be in a lower tax bracket in retirement.

Scenario 1: Same Tax Bracket in Retirement

Strategy 1: Invest 10% of your income each year into your RRSP and invest the tax savings each year into your TFSA.

Strategy 2: Invest 10% of your income each year into your TFSA only.

For scenario 1, we will hold the following constant:

Current marginal tax rate: 28.2%
Marginal tax rate in retirement: 28.2%
Annual growth on invested assets: 5.0%
Contribution period: 20 years

Scenario 1 Annual Contributions
Strategy 1 (RRSP & TFSA)Strategy 2 (TFSA Only)
Annual income
80,00080,000
Income tax owing13,86316,119
Annual RRSP contribution8,000
Annual TFSA contribution2,2568,000
Total annual contribution10,2568,000

By making the 10% RRSP contribution, you receive a tax savings of $2,256. After investing this amount into your TFSA each year, the TFSA balance will exactly equal the tax owing on the RRSP assets.

In Scenario 1, the end value of investing with strategy 2 (TFSA only) is equivalent to the end value of strategy 1 (RRSP & TFSA).

Scenario 1 Portfolio Values at End of 20 Year Period
Strategy 1 (RRSP & TFSA)Strategy 2 (TFSA Only)
RRSP Value
277,754
TFSA Value78,327277,754
Total Portfolio Value (pre-tax)356,081277,754
Tax Liability78,327
Total Portfolio Value (after tax)
277,754277,754

By making the 10% RRSP contribution ($80,000*10% = $8,000), you reduce your annual tax owing from $16,119 to $13,863 a tax savings of $2,256. By investing this sum into your TFSA each year, and assuming both the RRSP and TFSA investments grow at the same rate, the TFSA balance will exactly equal the tax owing on the RRSP assets as they are withdrawn assuming you are in the same marginal tax bracket each year of withdrawals.

But is this a true break even between these two investment strategies? Considering the above example, the following might be reasons to contribute an RRSP rather than put the entire amount in a TFSA in each year:

  • You may not have enough TFSA contribution room
    • Total TFSA room for those who have never contributed is currently $75,500
    • Allowable contribution room is set to increase by $6,000 each year
  • Tax deferral advantages
    • Use the tax savings to pay down other debt such as a mortgage
    • More assets working for you during your employment years
  • You may want to use RRSP funds to take advantage of the Home Buyer Plan and Lifelong Learning Plan
  • Diversification of investments/investment vehicles

Scenario 2: Slightly Lower Tax Bracket in Retirement

Now let’s look at whether it is advantageous to do an RRSP vs TFSA in the scenario where your income will be only slightly lower in retirement.

Strategy 1: Invest 10% of your income each year into your RRSP and invest the tax savings each year into your TFSA.
Strategy 2: Invest 10% of your income each year into your TFSA only

For scenario 2, we will hold the following constant:

Current marginal tax rate: 28.2%
Marginal tax rate in retirement: 22.7%
Annual growth on invested assets: 5.0%
Contribution period: 20 years

Scenario 2 Annual Contributions
Strategy 1 (RRSP & TFSA)Strategy 2 (TFSA Only)
Annual income
80,00080,000
Income tax owing13,86316,119
Annual RRSP contribution8,000
Annual TFSA contribution2,2568,000
Total annual contribution10,2568,000

After 20 years, the RRSP & TFSA combination scenario results in $15,276 more in after tax money.

In scenario 2, the end value of investing with strategy 2 (TFSA only) is inferior to the end value of strategy 1 (RRSP + TFSA) by $15,276.

Scenario 2 Portfolio Values at End of 20 Year Period
Strategy 1 (RRSP & TFSA)Strategy 2 (TFSA Only)
RRSP Value
277,754
TFSA Value78,327277,754
Total Portfolio Value (pre-tax)356,081277,754
Tax Liability63,050
Total Portfolio Value (after tax)293,030277,754

After 20 years, the RRSP & TFSA combination strategy in scenario 2 results in $15,276 more in after tax money than investing in the your TFSA alone. Think of what could be done with that money!

What do these two scenarios tell us?

  1. If your retirement tax bracket will be the same as your tax bracket now, while on paper the financial benefits appear to be the same, there could be advantages to investing in your RRSP vs TFSA.
  2. If your retirement tax bracket will be slightly less than your tax bracket now, there can be a huge advantage to investing in your RRSP vs TFSA alone!

Connect Wealth is an independent financial planning firm that offers holistic advice to clients based on their current goals and future aspirations. We use well-established workflows and cutting edge technology to maximize planning efficiencies while simplifying the process for clients. Learn how you can maximize your financial opportunities at www.connectwealth.ca

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