This is a question that I get a lot around this time of the year. Is a Tax Free Savings Account (TFSA) better than an RSP? Before I answer it, I would like to review some key comparisons between the two accounts.
- Amounts contributed to an RSP generate an immediate tax refund; TFSA contributions do not generate a tax refund
- All amounts in a TFSA can be received tax free, contributions, interest, capital gains etc.; All amounts in an RSP are taxed fully upon withdrawal.
- Funds can be withdrawn at any time from either account
- Both accounts are subject to annual contribution limits; however withdrawals from TFSA's are added back to contribution room the following year whereas RSP withdrawals do NOT work this way
- You CAN invest in the same types of investments in each account. This means you can access marketable securities, mutual funds, GIC's etc in both.
Here are some questions to ask yourself when making this decision.
1. Will I most likely be in a lower tax bracket when I withdraw these funds?
2. Will I save money today on my taxes owing or get a refund?
3. Will I invest the tax refund I receive?
4. Will I invest the money in either account the same way?
If you can answer YES to these questions, then an RSP is likely a better option for you. You can see from Figure 1 that even after paying tax on the full RSP at retirement, you end up with more dollars than if you just saved in a TFSA. The important thing here is the investment of any tax refund or savings back into the RSP. You essentially have more money to pay tax with. However, other things to note in this example though are that the tax rate is higher at the time of contribution AND that the overall average rate of return is the same in both cases. Often times, I notice that people tend to contribute to a TFSA and leave the funds sitting in savings because they are not aware of the many different investment options available to them.
Figure 1 RSP Versus TFSA Contributing $15,000 (re-investing initial RSP refund) Growth over 25 years; initial marginal tax rate 41% marginal tax rate at retirement 25%
If we do this calculation when someone is in the SAME tax bracket as they are today, there is no advantage to doing the RSP and in fact you could be worse off depending on your tax bracket. As a rule of thumb, if you have taxable income of under $47,000, TFSA's may make the most sense for the majority of your savings going forward. This is simply because when you retire, your tax bracket is likely to be same as it is now or possibly higher. Of course there are always exceptions so we can check your specific situation and run the numbers.
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Susan Brown CLU®, FEA, CFP®, RRC®, CIM®
Investment Advisor
IA Private Wealth ǀ Propel Financial Life Management
Insurance Advisor ǀ Propel Insurance and Advisory Inc.
T: 403-616-7699ǀ susan.brown@iaprivatewealth.ca