April 2015

Should you re-think your RRSP strategy
in favour of a Tax-Free Savings Account?

By Don Eberley

"He that is good with a hammer tends to think everything is a nail."

- Abraham Maslow

Canadians do love their RRSPs. The thrill of the late-February contribution. The sound of an envelope opening to reveal a tax refund cheque. It's like fresh-brewed coffee and a box of Timbits!

Some RRSP contributors have a high income, some low. Some have a pension, while others don't. Some plan to rely on their RRSP for a lifetime of income, while others are just stashing it away as a gravy fund. Some will even wipe out their plan early, to buy a home, cottage or new dishwasher.

In truth, the humble RRSP was never intended for many of these situations. It is quite possibly the most over-used financial instrument in Canada.


Perhaps the greatest misconception about RRSPs is that they help you avoid tax. But all they really do is defer it, which is the same thing as mortgaging your future if you spend your tax refund today. And this deferral could be a double-whammy if your personal tax bracket happens to be higher during retirement than it was when you made the contribution. In reaching for that RRSP tax refund "carrot", you really need to ask yourself if it is a trap.

Another point to remember about RRSPs is that all withdrawals are fully taxable as income. With personal tax rates in Ontario as high as 46%, plus up to an additional 15% in potential Old Age Security clawbacks, large RRSP withdrawals could pay you as little as 39 cents on the dollar. You might fall into this trap when making large purchases, such as a new car, or if you have other forms of retirement income, such as a pension or part-time salary. It could also happen if you die and leave your RRSP to your children, because that is treated as a lump sum withdrawal of the entire plan.

To summarize, RRSPs are best for people whose tax bracket is likely to decline during retirement, and who will be making small, regular withdrawals spread over many years. It also helps if they are disciplined with their tax refund cheques, using them to pay down debt or save for future tax bills.


On the surface, a Tax-Free Savings Account (TFSA) resembles an RRSP. It's a registered savings account in which you can hold cash, stocks, bonds or mutual funds. Unlike an RRSP, however, a TFSA does not reward contributions with a tax refund. What it does do that an RRSP cannot is reward you with a future income that is 100% tax-free (including the accrued profits) and completely invisible to the Old Age Security clawback test.

The benefits of tax-free, OAS-invisible withdrawals can be staggering. Whereas a $10,000 RRSP withdrawal could leave you with as little as $3,900 after taxes and OAS clawbacks, a $10,000 TFSA withdrawal will always leave you with $10,000. Imagine how much farther your money could go, or how much less you would need to save!

The "catch" to using a TFSA? (1) Annual contribution limits started small at $5,000 in 2009, rising to $5,500 in 2013 and $10,000 in 2015. Fortunately unused room carries forward indefinitely.   (2) You won't be getting that RRSP tax refund every April. But depending on how disciplined you are with tax refunds, this might be a good thing.

To summarize, a TFSA might be the superior retirement savings vehicle if your tax bracket is unlikely to decline, if you will have significant taxable income during retirement, if you will be making occasional large withdrawals, or if your income is likely to be in the OAS "clawback zone". It is also good for people who are not disciplined with RRSP tax refunds, or who might need a new dishwasher.


John earns $120,000 per year as a high-tech project manager. He has a large mortgage and no pension, but plans to live frugally during retirement. In fact, all he will really need is a $40,000 (pre-inflation) income from savings, plus government benefits. How should he do it?

John is a good candidate for an RRSP. His contributions will generate a large tax refund, which he can use to pay down his mortgage. Later on he will retire debt-free, and the RRSP income will be taxed at a relatively low rate... much lower than he is paying today. He will still qualify for full CPP and OAS benefits - about $17,000 per year starting at age 65 - for a total income of approximately $57,000 adjusted for inflation.


Sandy is a Director in the federal public service, and will retire in 15 years with an $80,000 inflation-adjusted pension. She is nearly debt-free already, and is wondering what to do with her surplus income.

Sandy is a good candidate for a TFSA. The additional income it provides on top of her pension will be tax-free and will not erode her OAS benefits. She can use the TFSA to regularly supplement her lifestyle, or as a "gravy fund" for those special expenses, such as a trip to Europe or upgrades to the cottage.


Joan is an office assistant who earns $39,000 per year and wants to save for retirement because she has no pension. She has simple tastes, and lives comfortably with very little debt.

If Joan can live without an annual tax refund, she should consider saving money inside a TFSA rather than an RRSP. Her current tax rate is low enough that she doesn't urgently need tax deferral. And by drawing a tax-free income during retirement, in addition to government benefits, she will pay little if any income tax. It's not a glamorous lifestyle, but it is a highly efficient one.


Veronica is a management consultant who isn't sure she will ever retire, because she loves her work and can reduce her hours anytime she likes. But she would still like to set some money aside just in case, and is interested in tax breaks due to her $130,000 income.

Veronica should consider a hybrid RRSP/TFSA strategy: Contribute to an RRSP, and invest the tax refund in a TFSA. This will give her some tax relief today, and a flexible plan for tomorrow which includes different "pots" of money to access depending on her tax situation at the time. She can draw RRSP income when her consulting income low, and switch to the TFSA when it is high.

Wondering about your retirement savings plan? Feel free to drop me a line to ask a question or arrange a private consultation.