The rise of the TFSA has pretty much killed RRSP season.
You can contribute to a registered retirement savings plan in the first 60 days of the year and have it count toward the previous year’s taxes. But you rarely hear January and February referred to as RRSP season anymore by financial companies and the media.
RRSPs have been around 50 or so years longer than TFSAs, they have much higher annual maximums and they offer a tax deduction on contributions while TFSAs do not. And yet, RRSPs have been eclipsed by TFSAs in popularity as measured by contributions. Too much so, if you ask some financial planners.
New products, accounts and thinking on finance can take ages to achieve acceptance, but TFSAs quickly took off after their 2009 introduction. A Statistics Canada study on RRSPs says the average annual contribution to TFSAs by families began to exceed those for RRSPs in 2014.
In 2020, the most recent year for which there is data, TFSAs had a 51.8 per cent share of savings by families in registered accounts, RRSPs were at 31.5 per cent share and registered pension plans at 16.7 per cent. Average family contributions to TFSAs were $12,205 that year, compared to $10,185 for RRSPs and $5,960 for pensions.
TFSAs are fantastic – let’s be definitive on that. You contribute with after-tax dollars and then benefit from tax-free compounding and withdrawals. The only real tax worry with TFSAs is the penalty on over-contributions, which continues to trip people up.
Once you turn 18, TFSAs can be used for pretty much any financial goal you can think of, including retirement. Low-income individuals should only use TFSAs because, unlike RRSPs, withdrawals in retirement do not affect the amount received through the Guaranteed Income Supplement.
RRSPs were created in 1957 and thus have a lot more assets – $1.3-trillion to $567-billion for TFSAs as of last June, according to Investor Economics, a division of ISS Market Intelligence. The maximum RRSP contribution for 2024 is 18 per cent of earned income up to $31,560. RRSP contribution room has grown year by year, whereas TFSA room is increased only periodically to keep pace with inflation. Yet TFSAs, with a $7,000 maximum this year, are the more popular brand.
“I think there’s some dislike of the fact that at some point, RRSPs become taxable,” said Natasha Knox, a certified financial planner at Alaphia Financial Wellness in New Westminster, B.C.
RRSP contributions are tax-deductible, a fact that used to be a big selling point. But when you withdraw money from an RRSP in retirement or any other time, you pay tax at your usual rate. This really bugs retirees, even if they can end up saving on tax overall.
Ms. Knox uses the example of someone who is in a high tax bracket while working and then moves into a lower bracket in retirement. The tax refund this person gets when making the RRSP contribution is more than the tax paid on an RRSP withdrawal in retirement.
“You’re massively saving taxes,” she said.
The role of RRSPs is one of the biggest misunderstandings among people saving for retirement, according to Jane Bolstad, a CFP with Trusted Financial Planning in Calgary. Often, she has to explain the benefits of RRSPs to clients who have been turned off by commentary highlighting the tax hit on withdrawals.
“With fewer people in pension plans these days, RRSPs should be a vehicle that is being used more, not less,” Ms. Bolstad said by e-mail.
Asked on LinkedIn why RRSPs have lost market share to TFSAs, financial planners and advisers offered these thoughts:
-Expensive housing has diverted money that might otherwise have gone into RRSPs
-More emphasis on real estate as an asset versus traditional investing through RRSPs
-Less disposable income as a result of inflation
-TFSAs seem more straightforward
The Statistics Canada study on RRSPs said the participation rate for TFSAs at the family level hit a record high of 39 per cent in 2020. The participation rate for RRSPs fell into decline in the late 1990s and reached 28.2 per cent in 2019. This rate edged up incrementally in 2020, a year when some people found themselves with extra cash as a result of pandemic lockdowns.
A self-defeating aspect of personal finance is a fixation on the perfect outcome or, in this case, the 100-per-cent best choice between RRSPs and TFSAs. Let’s acknowledge that saving money in either is a good outcome. If you want to do better than that – maybe in some cases pay less tax – give RRSPs a second look.
Are you a young Canadian with money on your mind? To set yourself up for success and steer clear of costly mistakes, listen to our award-winning Stress Test podcast.
Rob Carrick