It’s RRSP week here at Morningstar. And the clock is ticking, as February 29, 2024, is the official deadline for contributing to Registered Retirement Savings Plans (RRSPs) for the 2023 tax year. December 31 of the year you turn 71 years of age is the last day you can contribute to your own RRSP.
Canadians have multiple options for savings for retirement, and recently the tax-free savings accounts (TFSAs) have become more popular. According to a recent StatCan report, An increasing proportion of families contributed to a TFSA from 2009 to 2020, while proportions of those contributing to Registered Pension Plans (RPPs) and RRSPs stayed flat or declined over the same period. In 2020, the share of TFSAs (51.8%) exceeded those of RPPs and RRSPs combined (48.2%) as shares in total contribution to all three accounts.
So when does a TFSA rule over an RRSP? And how much to contribute to each?
When Your Income is Below $50,000 – TFSAs Rule
The general wisdom is that if an individual earns less than $50,000 per year, contributing to a TFSA makes sense since the earner is sitting in the lowest tax bracket. At that point, reducing taxable income won’t impact savings or lower the tax bracket any further.
One consistent theme that has popped up over the years when interviewing financial advisors about this topic is that long-term clients will fall into this bracket occasionally over the years. Some examples are a mother taking a few years off to care for her kids, a son taking a long-term locum to look after his parents or a client leaving work to pursue further education.
The Income Below $50,000 category isn’t only for lower to lower-middle income earners – it’s for all Canadians – and it’s an essential tool for advisors to have in their arsenal. To know exactly what to do if this happens to their clients.
Guaranteed Income Supplement (GIS)
As Alex Mazer, co-founder, and co-CEO of Common Wealth, a financial technology company that specializes in retirement plans, points out in Group TFSAs Can Beat Group RRSPs, Guaranteed Income Supplement (GIS) is another time that TFSAs trump RRSPs.
If the earner may qualify for GIS (the monthly payment for low-income Old Age Security (OAS) pensioners), it doesn’t usually make sense to save via RRSP; ultimately the person may lose some benefits because of the income from it. Plus, the RRSP must be converted to a RRIF in the year the person turns 71 years old. And every dollar withdrawn for a RRIF after the age of 65 reduces the GIS by a minimum of 50 cents.
Need Quicker Access to Money
When saving for a honeymoon, pet or vacation a TFSA makes more sense. The withdrawals are tax-free and aren’t penalized like they are with RRSPs. TFSAs beat RRSPs if the saver is focused on short to medium-term goals.
TFSA Cumulative Contribution Room
Many Canadians have more room than they think within their TFSA. The annual TFSA contribution limit for 2024 is $7,000. Your contribution limit starts the year you turn 18 and TFSA's were introduced in 2009. If you didn't contribute to a TFSA between 2009 and 2024 and you were at least 18 in 2009, your total contribution limit could be $95,000.
You TFSA contribution room number is available via CRA My Account for Individuals.
Of course, there is also Cumulative RRSP Contribution Room, but the bonus with TFSAs is that there are no withdrawal penalties. When money is withdrawn from an RRSP it is included as income for tax purposes.
Do keep in mind, as outlined on the Government’s website, at any time in the year, if you contribute more than your available TFSA contribution room, you will have to pay a tax equal to 1% of the highest excess TFSA amount in the month, for each month that the excess amount remains in your account.
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