RRSP – Registered Retirement Savings Plan

 

An RRSP [25] is a bit more complicated than a TFSA.

For the RRSP, you put in “pre-tax” money – that is, any money you put in you are not taxed on, so you get a tax deduction to use. Investments within it are able to grow and compound tax-free, and it frees you from some paperwork and reporting burden, just like the TFSA.

Your contribution room for an RRSP is not as simple as the TFSA. You get a certain amount of your income for each year as RRSP contribution room, up to a maximum per year, with an adjustment if you have a pension. To make it easy, the Canada Revenue Agency will calculate your RRSP contribution room and report it on your annual statement of account. The option to contribute and get a deduction for a given year continues for the 60 days into the next year, often called “RRSP season”.

When it comes time to take money out of the RRSP it is then taxed as ordinary income. You also don’t get the contribution room back (except for a few specific programs that allow you to borrow from your RRSP to buy a house or go to school) [26]. This means that you really should be sure you don’t need access to money in your RRSP until retirement. It also means that in a certain sense not all of the money in an RRSP is yours: some of it can be thought of as the government's portion that they will get back when you withdraw. So when comparing the RRSP and TFSA, you have to remember that you need to put more in the RRSP for the situations to be truly comparable, to account for the government’s portion.

The “no tax on contribution but tax on withdrawal” aspect makes the RRSP ideal for situations where you expect to be taxed less when you take the money out than you were when you put the money in. For most people that is the case when they’re saving while working and withdrawing when they retire. Other situations where you earn less can be good fits for the RRSP too, like withdrawing while on a break from work, whether that’s for an extended period of unemployment, a sabbatical, maternity leave, or going back to school. In the particular case of going back to school there is also the Lifelong Learning Plan (LLP), which lets you temporarily withdraw funds without losing contribution room or paying tax, with the requirement that you repay them on a set schedule.

A further complication of having withdrawals count as income is that taking money out of your RRSP could reduce the income-tested benefits you receive such as Old Age Security (OAS) or the Guaranteed Income Supplement (GIS), increasing your effective tax rate in retirement.

As to which account is better, the RRSP or the TFSA, that depends a bit on the person and their situation, but in general the TFSA is better for people in lower tax brackets [27] (and because those people make less, $5,500/year in savings might be all they have) while the RRSP is better for those in higher tax brackets, or who expect to be in a lower tax bracket come withdrawal time.

A simple rule-of-thumb [28] is that the TFSA room should be used first. The RRSP may end up being the most advantageous for some people, but the TFSA is more flexible if you need access to your savings in an emergency. Or, if you’re just starting out you may decide that you don’t like the bank or brokerage you chose. Whatever the reason, withdrawing from the TFSA, waiting until the next calendar year, and starting over is a nice option to have.

Moreover, the math that finds RRSPs are better for some situations in head-to-head comparisons assumes that the tax refund you get is also invested (or you take out a loan to put more in the RRSP in the first place, and pay it off with the refund). Many people, however, have a certain amount of cash in their chequing accounts and contribute that at the end of the month or year, and then their tax refund ends up being spent – becoming a vacation or big-screen TV instead of more RRSP investments. In that case the TFSA is the better choice as it doesn't tempt you into squandering a big part of your investment. And those in higher tax brackets where RRSPs are the clear winner will likely find that they have enough money to max out their TFSA and still put a large chunk into their RRSP anyway. Plus, in general TFSA accounts are largely without annual fees, no matter the size of the account, whereas some RRSP providers do charge annual fees for smaller accounts.

The big caveat to my TFSA-first advice is that you need to have the willpower to leave the investments in the TFSA unless you absolutely need them. If you can’t be trusted with yourself and need to lock your money away so it’s even harder to get at, then the RRSP is the better option. Also, some employers offer to match your RRSP contributions which should be taken first – it’s free money! See http://www.holypotato.net/?p=1403 for a TFSA vs RRSP decision guide.

 

Footnotes:

25: Often just called RSP, especially by the banks (they seem prone to dropping an R).

26: Note that you have to make the withdrawal through the program – your bank will have a special form for requesting a withdrawal through the Home Buyer’s Plan (HBP) or Lifelong Learning Plan (LLP) – you can’t just simply transfer money out of your RSP.

27: Roughly speaking, a low tax bracket would refer to someone making less than $40k/year.

28: Individual circumstances vary. If you are lucky enough to have a job that provides matching RRSP contributions, then use that first: free money trumps tax considerations every time.