There are two specific, and fairly common, situations where contributing to a Tax Free Savings Account (TFSA) for long-term retirement savings makes more sense than a Registered Retirement Savings Plan (RRSP). The first situation is where a person does not have any, or enough, RRSP contribution room. The second situation is where you have a workplace pension and expect to have a fairly large amount of pension income after retirement.
Canada Revenue Agency (CRA) tracks your contribution limit every year and you can find this on your annual Notice of Assessment that comes after your tax return is filed. You generate contribution room for yourself by having “earned income” – i.e. income from employment or self-employment. If you are very young and have never had income before, or if your income is all from investments (such as rental properties), it is possible that you will not have much, if any, RRSP contribution room. This means you cannot contribute to your RRSP until you generate sufficient earned income. In this case, making use of a TFSA for your long-term savings is your best/only option.
As I noted in Part 2, there is also an annual contribution limit for your TFSA, but it is not based on earned income – everyone gets the same contribution room every year. And it is cumulative over your lifetime, which means any contribution room you do not use can be carried forward to the next year, with no limit on how long it is carried forward.
I should also point out here that your financial institution will not necessarily know your RRSP or TFSA contribution room, or stop you from over-contributing. If you do, even by mistake, and you don’t withdraw the excess funds in a timely manner, it could lead to potentially large amounts of additional tax charged by CRA.
The second situation, where you have a workplace pension and expect to have a fairly large amount of pension income after retirement, is likely more common than the first situation. Having a defined benefit pension could lead to two separate but related issues, both of which take away the RRSP advantages discussed in Part 3.
The first issue would be the possibility of generating zero absolute tax savings by using an RRSP. If your taxable income after retirement is roughly the same as (or higher than) your current taxable income, this will be true. In these cases, the refund you receive when you contribute to your RRSP would be the same as (or less than) the tax you will pay when you withdraw from the RRSP at some point down the road. With a healthy pension income, along with annual Canada Pension Plan (CPP) and Old Age Security (OAS) benefits plus any other income sources, this is actually not all that unusual. This will be particularly true for Millennials working in the public sector given the proposed enhanced CPP benefits to be received by today’s younger workers.
The second issue is, once a person is 65 years old and their taxable income goes over a predetermined threshold, the government begins to take back a portion of that person’s OAS benefits, referred to as “OAS clawback”. Because RRSP withdrawals are included in taxable income, contributing too much to the RRSP during your working years could inadvertently cost you money in retirement.
If you believe this last situation may apply to your current circumstances, or if you are still not sure where to invest your savings or where to find your contribution limits, do not hesitate to contact a tax or personal finance professional to discuss your options.
*The blogs posted on this website provide information of a general nature and should not be considered specific advice. Please contact a professional accountant prior to acting upon or implementing any of the information included in the blogs.