TFSAs over RRSPs this year, especially if you’re in debt

Will you be taking an RRSP season guilt trip this winter?

March 1 is the deadline for making a registered retirement savings plan contribution that counts toward your 2022 taxes. For those who have the bucks, it happens be a good time to put money in an RRSP because stocks and bonds are looking up after last year’s losses and 5-per-cent guaranteed investment certificates are still available.

If a heavy debt load is stopping you from making an RRSP contribution, skip the guilt trip and focus on debt over saving. As much as we all need to take a long-term view with our finances, there are times when living in the moment takes priority.

It looks right now like borrowers will have to wait another 12 months or so before interest rates start to move lower. The wait will be difficult because the full impact of last year’s rate hikes is just starting to be felt. It takes 18 to 24 months for higher rates to seep fully into your finances and the broader economy.

Complicating the outlook is the risk that high rates drive the economy into recession. For this reason, tax-free savings accounts look good compared with RRSPs if you do have some money to put away. TFSA money held in a high-interest savings account can be pulled out in a flash if you need it. It’s the ideal emergency fund.

RRSPs are a second-best source of funds, although it’s common for people to withdraw money from them. A Statistics Canada study last year said that $1 is withdrawn annually for every $5 saved in RRSPs by tax filers of working age.

A federal withholding tax applies to RRSP withdrawals – as much as 30 per cent on withdrawals over $15,000 or more in all provinces but Quebec, and 15 per cent in that province. Additional taxes may apply if you’re in a mid- to high-tax bracket because the amount of your RRSP withdrawal must be added to your annual income.

Also, money can be taken out of a TFSA at no cost in most cases, whereas investment companies may charge fees for partial RRSP withdrawals. TFSA money can land in your chequing account in 24 to 48 hours at most, while it can take several weeks for an RRSP withdrawal to be processed.

A further argument against withdrawing money from an RRSP is that you can’t recontribute that amount later on. You can withdraw money from a TFSA and put it back later, as long as you follow the contribution rules.

It’s true that an RRSP contribution generates a tax refund that seems like found money when it arrives. The old standby compromise between investing and paying down debt is to make an RRSP contribution and apply the tax refund to your debt.

TFSAs don’t offer a tax refund because you contribute to them with after-tax money. But they do give you a place to save or invest that you can access any time without the complication of owing tax. That’s worth something for households feeling financial stress.

The latest interest-rate developments add some urgency to financial decisions made by people carrying serious debt. Earlier in the week, the chairman of the U.S. Federal Reserve talked about how stubborn strength in the job market is helping to sustain inflation.

For rates to drop, we need inflation to start falling in a meaningful way from current levels. The Fed sized up the January U.S. jobs report as a warning that inflation is stubborn and yet more rate increases may be required. Inflation seems a little more docile in Canada, but the latest round of forecasts from bank economists suggests rate relief won’t happen until late this year or early next.

For example, BMO Economics published a rate outlook last week in which the Bank of Canada’s benchmark overnight rate remains stuck at 4.5 per cent until the first quarter of 2024, then declines to 3.5 per cent by the end of that year. CIBC Economics has the overnight rate at 4.5 per cent all year, then down to 3 per cent by the end of 2024.

The wait for lower rates will test the financial resilience of indebted households. It’s okay to prepare by forgoing RRSPs this year and starting to catch up on retirement saving when rates normalize down the line.

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