If you’re self-employed or a small business owner, saving for retirement comes with its own set of challenges:
- You don’t have access to an employer-funded savings plan
- You’re putting as much of your own money into the business as possible
- You’re so focused on growth that saving for retirement gets pushed to the bottom of your priority list
But there are simple things you can do right now to make a difference to your retirement savings.
Are you investing in a registered retirement savings plan (RRSP) or tax-free savings account (TFSA)?
If you’re not, you’re missing out on tax savings.
But you might be wondering, should I use a RRSP or TFSA?
The answer is both if possible — and you should max them out as much as you can.
But depending on your tax bracket and when you need the money, you might want to choose one account over the other.
We go over the key differences between a RRSP and TFSA to help you determine which one is right for you.
Should I contribute to a RRSP?
Contributions to a RRSP are tax deductible so you receive immediate tax relief and tax-sheltered growth.
But when you withdraw the money, it’s taxable.
A RRSP is a good option if you’re earning a high income.
To maximize the benefits of the RRSP, you should contribute to it when you’re in a higher tax bracket and withdraw from it when you’re in a lower tax bracket.
Let’s look at an example:
- You make $120,000 in 2019 and contribute $15,000 to your RRSP
- The CRA will tax you on $105,000 of income instead of $120,000, since the contribution is tax deductible
- You pay tax on the contribution in the year you withdraw it so if you take out the money in your retirement when you have a lower income, you’ll pay less tax
How much can I contribute to a RRSP?
Your contribution room is based on earned income.
For 2019, you can deduct RRSP contributions to 18% of earned income, up to a maximum of $26,500.
To find out your contribution room for 2019, review your latest notice of assessment or notice of reassessment.
You can also find it on a T1028 form, which the Canada Revenue Agency (CRA) sends you if there were changes to your RRSP deduction limit since your last assessment.
The deadline to contribute to your RRSP for the 2019 tax year is March 2, 2020 (March 1 is a Sunday).
What is the age limit for contributing to an RRSP?
The RRSP must be fully withdrawn or transferred to a registered retirement income fund (RRIF) or annuity by December 31 in the year you turn 71.
Otherwise the CRA will include the entire amount of your RRSP in your taxable income that year.
Contributing to a spousal RRSP
You can also contribute to a spousal RRSP to help even out retirement savings for you and your spouse if they earn a lower income, since contribution room is based on earned income.
Your spouse would open a spousal RRSP account in their name (separate from their personal RRSP account), and you could contribute to the spousal RRSP.
Be careful not to go over your RRSP contribution limit. If you max out your RRSP, you can’t contribute to the spousal RRSP.
When your spouse withdraws the money in retirement, they’ll pay the tax on the withdrawals at their lower tax rate.
Should I contribute to a TFSA?
With a Tax-Free Savings Account (TFSA), you won’t receive up-front tax relief - but your money accumulates tax-free and you won’t be taxed on the withdrawals.
Any investment income in your account, and capital appreciation from stocks and bonds, is also tax-free.
Unlike a RRSP, you don’t need earned income to accumulate the contribution room in your TFSA.
In 2019, the amount you can contribute to your TFSA was increased to $6000 per year.
There’s technically no deadline to contribute to your TFSA.
If you haven’t maxed out your TFSA, you can carry any unused contribution room into the next year.
You can also withdraw from your TFSA at any time, and withdrawals free up more contribution room for you in the future.
Is a RRSP or TFSA better for me?
There are a few questions you should ask yourself when deciding which one is better for you:
1. What is your current tax bracket?
2. What do you think your tax bracket will be in the future?
3. When do you think you will need the income?
4. Are your federal and/or provincial benefits affected?
Most people are in a higher tax bracket during their employment years. If this applies to you, investing in an RRSP is your best bet to take advantage of a reduced tax rate when you withdraw the money.
But if you’re saving for a vacation or a down payment on a home, a TFSA will allow you to contribute up to $6,000 per year in a tax-sheltered investment, free to withdraw at any time.
Still unsure is a RRSP or TFSA is right for you?
Below are some scenarios that may help you.
If you’re earning less than $47,000:
- A TFSA should be funded first, since you are in the lowest tax bracket and reducing your taxable income won't further lower your tax rate
If you’re earning more than $95,000:
- In this case, your tax rate approaches 40%, therefore investing in a RRSP will benefit you the most by bringing down your taxable income
If you’re earning between $47,000 and $95,000:
- You may want to consider funding your RRSP and TFSA equally until you max out your TFSA
When should I contribute to an RRSP first?
- If you have a matching contribution retirement or pension plan with your employer, maximize your contributions before considering a TFSA
When should I contribute to a TFSA first?
- If you think your income after retirement age will be greater than what you earn now, your money should go into your TFSA first. It’s better to pay the lower income tax rate on that money now, than the higher rate you'll pay when you take it out
- If you think you might need the money before retirement age, TFSAs are more flexible and you won’t pay any taxes upon withdrawal
- If you’re in retirement, and you’re close to your Old Age Security claw back amount, consider withdrawing more money from your TFSA as opposed to your RRSP as these amounts won’t be added to your income
To summarize, it’s a good idea to contribute to both if possible.
If you contribute to each account every year and invest the money, you’ll make a big difference to your retirement savings.
Disclaimer: The material above is provided for educational and informational purposes only. Please contact a tax professional like FBC regarding your specific tax situation.