RRSPs versus TFSAs: A credit counsellor weighs in on the debate


Investments don’t need to be complicated, but if RRSPs are your only emergency fund, you’re setting yourself up for disaster

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Even though the deadline for contributing to your registered retirement savings plan (RRSP) for the 2021 tax year is right around the corner on Mar. 1, it’s never too late to discuss the pros and cons of RRSPs. 

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Although they have received a bad rap in the past few years due to the tax implications of early withdrawal, that doesn’t mean they can’t provide some advantages if used correctly. 

The biggest advantage of an RRSP is the tax benefit you receive when making a contribution. Any contribution you make to an RRSP is tax deductible, which can result in a bigger tax refund or a reduction in the amount of income tax you owe. Your goal for investing in RRSPs should be to save for retirement when your expected income and tax bracket will be lower.

The idea is to reduce the amount of income tax you must pay now while you are working. Then, when you retire and your income decreases, you can withdraw from your RRSP and pay taxes on withdrawals at your lower/retirement income level. People run into trouble when they cash out an RRSP early and end up owing that year for the previously deferred tax.   

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Another benefit of investing in RRSPs is that under the Home Buyers’ Plan, a first-time homebuyer can borrow up to $35,000 from their RRSP to purchase their first home. The government then allows them 15 years to pay the money back to their RRSP. Any year in which they do not recontribute a 1/15 portion of what they took out, the unpaid amount is taxed as their last dollar earned. It is important to budget carefully and recontribute each year towards what you borrowed, but you also must designate it as Home Buyers’ repayment on your tax return.  

Registered retirement savings can also come in handy if you or your spouse decide to return to school. Under the Lifelong Learning Plan (LLP), you can borrow up to $10,000 per calendar year from your RRSPs towards full-time training or education, to a maximum of $20,000 each time you participate in the LLP program. You may then take up to 10 years to repay what you borrowed. Just like with the Home Buyers’ Plan, any year in which you do not recontribute and designate it as such on your taxes (1/10 for LLP), you will be taxed on it as if it were income.   

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Any amounts contributed to an RRSP that are more than 12 months old are protected in the event of a bankruptcy. Not that anyone plans on becoming insolvent, but should you find yourself in dire straits, you won’t have to sacrifice future retirement savings to eliminate today’s debt.  

However, despite all the pros of an RRSP, the drawbacks are worth keeping in mind. One of the biggest is how you view your RRSP: is it your emergency savings fund or is it money for retirement? Withdrawing money from an RRSP during your working years to cover an emergency expense comes with hefty tax consequences. Every dollar you take out is added to that year’s income. That affects the amount of income tax you must pay as well as any income-based government programs you qualify for. 

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To avoid having to use RRSPs for emergencies, diversify your savings. RRSPs are not meant to be short-term savings. Open a savings account or non-registered investment to sock away emergency funds. There won’t be a tax break on this money, but you also won’t be penalized on your taxes for using the money to repair your car or buy a new hot water heater. And there won’t be credit-card interest to pay on these expenses because you’ll have cash for those bills. 

This is where a tax-free savings account (TFSA) might be helpful. TFSAs, rightfully so, have been all the rage since their introduction in 2009. Contributions to a TFSA are made with after-tax income and grow tax sheltered; you don’t pay income tax on the interest you earn. Any withdrawals are not taxed as income because you paid income tax on the money before it went into the TFSA. There is no tax deduction available for TFSA contributions like there is with RRSPs, but there is also no drawback to using the money when it’s needed.  

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Both TFSAs and RRSPs have annual contribution limits, but you regain your TFSA contribution room the year following any withdrawal. For example, if you take $2,000 out of your TFSA this year to go on vacation, the $2,000 is added to your annual contribution limit next year. If you take $2,000 out of your RRSP this year, you will not regain the contribution room in your RRSP and the amount you withdrew will count as income with a tax portion held back at source.  

Investments don’t need to be complicated, but if RRSPs are your only emergency fund, you’re setting yourself up for disaster. Seek the advice of an investment professional who can help you determine which products are best suited to meet your short- and long-term financial goals.  

Sandra Fry is a Winnipeg-based credit counsellor at Credit Counselling Society, a non-profit organization that has helped Canadians manage debt for more than 25 years.

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