RRSP vs TFSA - The Ongoing Debate
Hello All,
If you search for RRSPs vs TFSAs on the internet, there are about 3.6 million results (some of which I have linked to in the past). But, since the RRSP deadline is approaching and I have spent many hours contemplating and discussing the topic, I thought it might be an opportune time to have a brief discussion. Like most money topics, it isn’t necessarily super exciting , but a good decision can literally make you richer.
So, a TFSA (tax free savings account) is a savings account that you contribute to from after tax dollars (i.e. there is no tax deduction for contributions) but all of the investment income earned in the account is generated tax free in perpetuity (or until CRA decides to change something)
An RRSP (Registered Retirement Savings Plan) by contrast is also a savings account but you contribute to it with before tax dollars i.e. you receive a deduction against your net income up to an annual maximum amount. The investment income earned in an RRSP account is not tax free but rather tax deferred. This means that when you withdraw funds from your RRSP (usually when you retire), you pay tax on the amount withdrawn, at your tax rate, in the year of withdrawal.
Setting up either a TFSA or RRSP is simple: you determine your contribution room and go to a financial institution which can be one of the big 5 banks, a boutique bank, a brokerage, robo advisor etc and create an RRSP and/or TFSA account. You then decide what type of investments you would like to hold in the account eg. fixed income GICs, stocks, bonds, mutual funds etc. all of which have different levels of risk. Whatever allocation you choose can be changed over time so your investment choice is not carved in stone. It should be noted that the closer you are to retirement age, the less risk you should assume in your investment portfolio and as such shifting your allocation to less risky investments is something that should be done actively.
Of course everyone wants to know which is better. In a perfect world, you would contribute the maximum allowed to both every year. In an imperfect world, where many of us only have a limited amount of funds to contribute, the decision becomes more complex.
If you are young, don’t have significant earnings but expect your earnings to increase as you put in more years into your career or business, it makes sense to max out your TFSA and then use any leftover funds to contribute to your RRSP. The reason for this is that the tax deduction for the RRSP is based on the highest tax bracket that is applicable to you in any given year. Consequently, the higher your tax rate, the higher the deduction against income and corresponding reduction in taxes. This is not applicable to TFSAs since there is no deduction for contributions to TFSAs.
That being said, regardless of which vehicle you choose, the power of compounding with any type of investment is significant. As an example, $5,000 per year over 30 years i.e. a total investment of $150,000 invested at 5% (which is lower than the average return on the stock market) would result in $338,899.11 at the end of 30 years. ( You actually earn more than you invest!). In other words, the younger you are when you start investing the better this looks. (You can do your own calculations here to motivate you to start investing.)
It should also be noted that contributions for both TFSAs and RRSPs are cumulative. This means that if you invest less than the maximum allowable amount per year, the difference is added to the total you can contribute in future years. You can also withdraw from both the TFSA and RRSP. If you withdraw from your TFSA, you can recontribute the amount withdrawn at the beginning of the year following the withdrawal. With RRSPs, however, you simply lose the contribution room. Note that it is better to view RRSPs as a retirement fund that you should only withdraw in extenuating circumstances. TFSAs conversely can be viewed as a savings account or emergency fund that you can use when necessary.
So, while it depends on each individuals circumstances which includes age, income, tax brackets etc.,as long as you are contributing to one or both, you are making the right decision. And the best time to do it, even if you only can only do small amounts at a time, is as soon as possible.
Blog Post
Dividend declarations are due February 28th. Below are a couple of posts that explore the salary vs dividend question as well as guidance on doing the T5s declarations:
Consider These Factors When Deciding Whether to Take Salary or Dividends
One of the most common questions I get asked by corporate business owners is whether to take salary or dividends and how much tax can be saved by taking only dividends. The answer unfortunately, like
How to Pay Dividends: Completing the T5 Slip and Summary
If you are the owner of a Canadian corporation, you can choose to pay yourself (and other shareholders) dividends instead of a salary. Alternatively, some shareholders also take dividends in addition
Small Business Articles/Tips
Financial Rules of Thumb: An interesting explainer from the Blunt Bean Counter on a series of financial rules pertaining to retirement including savings rates, how much to spend vs save and big ticket purchases.
State of Remote Work: A survey from Robert Half reveals 5 trends in remote work. It seems that remote work is here to stay and employees are amenable to salary negotiations for the privilege.
Business Proposal Tips and Templates: A detailed post from Shopify on how to write a business proposal, how to follow up and where to find templates.
Tax Stuff:
Get Ready for Taxes! Relevant information from CRA relating to taxes for individuals and small businesses
2023 Car Expenses and Benefits: A comprehensive guide from PwC for those of you who use your cars for business and are understandably confused about the “maze” of rules and regulations
RRSP Explainer: This article delves into the various rules around RRSPs .
QuickBooks Tip:Allocating Interest and Penalties
Interest and penalties on late or overdue payments of taxes are not tax deductible. Consequently, these should be allocated to a separate account. The best way to do this is to create a separate “interest and penalties” account on the profit-loss, separate out any interest/penalties paid as part of a tax payment and allocate it to this account (you are allowed to enter multiple lines for each expense). When doing your tax return, these amounts are either excluded on the T2125 or added back to net income on the T2 (corporate tax return) Schedule 1.
Books and Resources:
Small Business Tax Facts(Sole Proprietorships/Registered Businesses/Self Employed Workers)
This book helps you have a better understanding of tax (brackets, tax rates, deductions etc), how it applies to your unincorporated small businesses and how to do your own tax return (or at least understand what your accountant does). It also includes a comprehensive breakdown of deductible expenses, by category with special sections on more complex deductions such as home office, vehicle and capital cost allowance.
FastStart Your Corporation(Corporations)
A step by step guide to starting your small business corporation, including what you need to know about incorporation, setting up your accounting and tax considerations.
QuickStart your QuickBooks(Sole Proprietorships and Corporations)
A comprehensive guide that takes you through the many features of QBO and gives you step by step instructions on how to setup and work with QBO day to day. It is ideal for beginners who have never used QBO before and also for those who are currently using it, but have questions or need guidance.
FastStart Your Business (Sole Proprietorships)
A step by step guide for anyone who is planning to start a Canadian business or become self employed (and does not want to incorporate) and wants to know what they need to do or simply has questions.
Small Business and Your Dividends (Corporations)
For incorporated small business owners who want to know more about small business dividends, the differences between salary vs dividends and which is better and step by step instructions on how to file your own dividend declarations (T5s).
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Free Resources
Business 2023 Tax Deadline Calendar (New!)
Starting A Corporation Checklist
Start Your Business Checklist
Dividend Declarations Checklist
Small Business Tax Return Checklist
QBO Set Up Checklist.
Small Business Calculators
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Wishing everyone a lovely weekend.
Ronika