Falling out of love with RRSPs

Robb Engen hasn’t put a dime in his RRSP for three years. The Lethbridge, Alta.-based business development manager and financial blogger, stopped investing when he moved to the public sector and was able to take advantage of a defined benefit plan. While the pension plan reduces his need for an RRSP, he abandoned his once-favourite retirement savings vehicle for another reason: he’s fallen for the tax-free savings account.

More than 5 million Canadians have opened a TFSA since it was introduced in 2009, but it’s really only now—with $20,000 in contribution room ($5,000 a year since ’09)—that it’s making a play to become Canada’s main retirement savings account.

“Last year seemed to be the backlash of the RRSP,” says Engen, who tries to max out his TFSA every year. “For me, in my 30s, the TFSA has a lot more potential.”

That’s how a lot of younger Canadians are thinking these days, says Frank Wiginton, a Toronto-based CFP and author of How To Eat An Elephant: One Day a Month To Financial Success. The TFSA, he says, “is the most powerful tax planning tool the federal government has given us.” The reason, he explains, is that, unlike the RRSP, money in the TFSA isn’t subject to income tax. With many people now retiring at the same, or higher, tax rate as had during their working years, this one difference between the two accounts is huge.

The only way an RRSP makes sense these days is if you know you’ll pay a lower tax rate in retirement. If you’re a diligent investor and save thousands of dollars over your lifetime, you could end up paying 46%, the highest tax rate, on your money. If you pass away before your account is drained all the leftover savings could also get taxed at the highest rate. This would defeat the purpose of the RRSP.

Wiginton says that people need to consider their lifetime tax bill when deciding which account to use. If you think you’ll have a lower tax bracket in retirement then the RRSP may make sense. If not, use a TFSA. “Think about how much tax are you likely to pay over your lifetime,” he says.

The CFP, who runs the website rrsportfsa.ca, says an RRSP makes sense for people earning between $75,000 and $120,000 a year. There’s still a good chance you’ll have a lower tax rate in retirement. But, he admits, that’s not statistically proven, just an assumption.

For people making more than $120,000 a year, invest in an RRSP and TFSA. Max out the RRSP first—since the tax rate is already 46%, the tax rate can only be the same or lower in retirement—and then put money in the TFSA.

If you make less than $75,000, the advantages of an RRSP start to disappear. The lower you earn the less useful it becomes. Anyone making less than about $41,000 should forget about an RRSP. The tax rate is too low, so you likely won’t get a break when you withdraw. Also keep in mind that the Guaranteed Income Supplement payments you receive in retirement are taxed based on your income. If you have to pay, say, 22% on your RRSP savings, you’ll have to pay that much on GIS too. If you take money out of a TFSA instead, you’ll only pay tax on GIS and it’ll likely be at a much lower rate.

For Engen, there’s no contest—the TFSA is better than an RRSP. “It’s more flexible and I can see a scenario where I’ll earn more than in retirement than what I was contributing when I was working,” he says. “I don’t want to end up paying more tax.”