If you spend that RRSP refund then TFSA makes more sense

If you spend that RRSP refund then TFSA makes more sense

Every year there are articles discussing the merits of contributing to the Tax Free Savings Account (TFSA) over the Registered Retirement Savings Plan (RRSP) or vice-versa.  

Today’s post is to remind you about a key benefit of the RRSP over the TFSA: if you spend the RRSP-generated tax refund the TFSA always makes more sense.

Read on.

Most of the articles tout an RRSP is an excellent savings tool for retirement – no doubt. 

I have a self-directed RRSP account myself and I contribute to it and try to maximize contributions to this account every single year.

In fact, I’ve been contributing to my RRSP since my mid-20s.

My RRSP is now maxed out of contribution room in my late-40s. 

Two major benefits of the RRSP

Contributions to the RRSP are excellent because the contribution you make today lowers your taxable income – and you may get a tax refund because of it – pretty nice formula. 

The problem I see with some people who contribute to their RRSPs, is they view the tax deduction as a big driver to contribute to the account in the first place only to use the tax refund for something else. 

That’s not wise.

If you consider this RRSP-generated tax refund a “gift”, that is, you are going to spend it all then you’re not really harnessing the power of the RRSP. 

Let’s dive deeper and revisit two key advantages of RRSPs:

  1. The tax deduction today, and
  2. The tax-deferred growth.

1. Tax deduction

Consider working in the 40% tax bracket:

  • If you put $300 per month into the RRSP for the year, that’s a nice $3,600 contribution.
  • You’ll get a $1,440 refund (40% of $3,600).

When your $1,440 cheque arrives, you decide to spend it on a trip to Cuba to escape our long, cold-winter.  Sounds like fun…I’d love to do that too!  When you do that however just know this $1,440 refund is effectively borrowed money – a long-term loan from the government they are going to come back for, in whole or in part (more on that in a bit).  

“If you always spend your RRSP-generated tax refund you are undermining the effectiveness of your RRSP because you are giving up your temporary government loan designed for tax-deferred growth.”

A refund associated with your RRSP contribution should not be considered a financial windfall but present value of a future tax payment you must make.

To really harness the power of your diligent RRSP contributions make sure you understand what you are going to do with your RRSP-generated tax refund. Consider the following as leading options:

  1. Reinvest it back into your RRSP (best bang for your RRSP buck) OR
  2. Contribute the RRSP-generated refund to fund your TFSA contribution OR
  3. Pay down your mortgage (a guaranteed rate of return on paying down debt).

If you typically spend the $1,440 “gift” in my example then I think you’re better off prioritizing your TFSA over your RRSP.

2. Tax deferred growth

At some point, the money that comes out of your RRSP will be taxed.  

The tax man will find you and he will ask for his refund.  In my example, that’s your $1,440 if your marginal tax rate in retirement is the same as your working years today.  It could be lower but with your Canada Pension Plan (CPP), Old Age Security (OAS), pension income and other investments, it could be higher.

With TFSAs, the government has eliminated the guesswork about how much the payback will be for the loaned money – because you don’t get any.  You don’t get any tax break on the TFSA contribution so the government is nice enough to offer tax free withdrawals coming out.  Even though TFSAs have largely been marketed as a “savings account” I have always suggested you open a TFSA to hold equities in the form of stocks or ETFs for many years – for long-term tax-free growth.

Personally, I have no idea of what my tax rate will be 20 years from now.  I can guess but that’s about it.  I have a pension and other investments.  I’ll calculate all this out in a few decades when I’m a few years away from retirement age and ready to start accepting some  income from government programs…if they still exist! 🙂

If you know for sure your tax rate will be significantly lower in retirement than today, RRSP contributions are a wise thing to do.  If not, making the TFSA a higher priority might be a better choice.  

Contributing to the TFSA today removes any guesswork about future marginal tax rates or any other federally income-tested programs down the road.

TFSAs – Withdrawals are not considered taxable income.  Income-tested benefits and income tax credits such as the GST Credit, Old Age Security (OAS) and the Guaranteed Income Supplement (GIS) aren’t affected by any TFSA withdrawals.  Withdrawals don’t reduce these benefits.RRSPs – Withdrawals are considered taxable income.  RRSP withdrawals could reduce amounts you receive from income-tested benefits and income tax credits such as the GST Credit, OAS and GIS.  RRSP withdrawals could reduce your post-retirement government benefits.

If you spend that RRSP refund then TFSA makes more sense summary

I’m not suggesting to use one account exclusively over the other.  

Both accounts have great merits so you use both if you can! 

I contribute to both my RRSP and TFSA every year but the TFSA takes priority and likely always will.

But the biggest takeaway from this post is not to blow the RRSP-generated tax refund. You are robbing your future financial self if you do. 

What’s your take on the RRSP vs. TFSA debate?

(Note: originally published in 2012. Not a typo. I continue to refresh a few words here and there over time in this post to demystify the RRSP vs. TFSA debate. Ha.)

More Reading:

RRSP information from our Government of Canada.

RRSP facts you must remember this year and beyond!

Thanks for reading.

24 Responses to "If you spend that RRSP refund then TFSA makes more sense"

  1. Hi Mark: Yes it is a good problem to have as it beats the alternative. I just wish that Justin hadn’t raised the brackets. I invest to the max in the TFSA but as soon as I was laid off stopped contributing to the RRSP as future income would be classified as interest (dividends, interest, capital gains and losses, etc.) inside an RRSP. Outside I get to use the money and since my RRSP is small compared to the rest of my portfolio it should not hurt me to much now that it is turned into a RRIF. The snowball of dividends keeps on growing and as such so do my taxes. I was talking to a friend and he said look how much money I’ve saved by building my RRSP so I said how much do you have and he said $3.4 MIL. I said and it is all in the RRSP and he said NO about a half so I did the math and that would be $51000.00 that the government would take out when he turned 72. Not a nice thought.

    1. That’s a pile of money invested for sure but you are correct, your friend will need to pay back their government loan – lots of taxation owing.

  2. Hi Mark: Great post! I didn’t think you could max out your RRSP so that you had no room in it to invest. I was thinking that if you did max it out starting in your 20’s than you must have a pile in it now and when you get to 72 the government is going to take a lot. Yes, it is me the person who doesn’t believe in RRSP’s mainly because of that last sentence. I remember in “85 I gave a friend a ride home from work and I was complaining about the income taxes and he knew the type of job I had so said that it wouldn’t be that much and I told him how much I had to pay and he was impressed as he was an engineer and I was a mail boy.

    1. Well, with the FHSA you can move it in – the government says you will be able to do so!

      I’m of the opinion that if you’re (constantly) complaining about taxation you’re making good money and that’s a good problem to solve 🙂

  3. I very much like your comment that the RRSP generated tax refund is really the Present Value of a future tax payment. That is a very accurate and analytical view of it.

    I agree with your analysis of TFSA vs RRSP, but it did miss an aspect that many individuals are have, where an Employer has a benefit plan that makes some type of matching contribution. (e.g. match your RRSP contribution, up to 4 % of your salary). I further agree the best use of the current year refund is paying down existing interest bearing loans or a TFSA contribution.

    On a related note, I enjoy your weekly blog.

    1. Fair point Matthew, re: employer part and workplace benefits. I have no concerns if folks take the employer “free money” of course for their RRSP matching/contribution, very smart to do so but that may or may not max out their total, personal, contributions available based on earned income.

      I appreciate the kind words and thanks for your readership!

  4. Great article Mark!

    In the end, there isn’t much difference between the RRSP and the TFSA if you use it for retirement. But having the discipline of reinvesting your RRSP tax return is harder than simply sending money over to your TFSA and don’t think about it!

    1. @BTI,

      Thanks man. I think you’re wise to tackle that mortgage and RRSP. That approach should have your house paid off rather quickly. You can always play catch-up with your TFSA, that’s the beauty of that account. As you know, it’s there to max. out whenever you want.

  5. I like that you threw in the table in there! That’s awesome.

    I agree that the RRSP is just a glorified loan to yourself.

    I don’t even think it’s that great to use for the Home Buyers Plan either. I’m just paying back the minimum and then will focus on my TFSA.

    1. Well thanks Y&T, I added the table for you!

      Kidding aside, the TFSA is a government gift to everyone. I just hope I can maximize it every year for the next 25 years and I’ll be in great shape for retirement 🙂

  6. @TheDailyThinker Thanx for the comment, and I wouldn’t say I’m trying to create a rebuttal here. The reality is we are all in different situatiions, different incomes etc. There really isn’t a one size shoe fits all scenario.

    However as MOA, points out you really need to look at the RRSP as a government loan – sure you get the refund, but you pay it back later. Yes its harder to take out your money from an RRSP than a TFSA. I do get that.. but don’t let that be the decision maker – you need discipline to use any investment strategy 😉

    Again, if you have a higher disposable income the RRSP is a better choice – not the other way around. That’s becuase you get a larger refund with a higher income. The TFSA is especially suited for those who aren’t higher income earners. As mentioned your RRSP deduction is lower with a lower income 🙂

    The TFSA means you don’t pay tax on the withdrawals. What’s not to get about that point? DO you really want to pay more taxes in retirement?

    But hey, as long as you are saving and investing, then that is the important point 🙂


  7. That was the best and simple explanation, why TFSA is better that RRSPs. I do not put money into RRSP any more. All goes into TFSA and Non registered investments.

  8. Mark, I enjoyed reading your post as usual. I agree that the TFSA might turn out to be the better investment tool. A man doesn’t have to be a prophet to predict that taxes will go up and up in the future. Let’s just think of all the federal and provincial deficits, the stagnant global economy, the aging population, the rising health care costs and last but not least the ever increasing appetite for social programs. Who is going to pay for all this- we will one way or the other. It doesn’t sound realistic- let’s turn eyes to Europe. So, it may turn out out that in 30+ years even if my (or anyone’s) income decreases in retirement, the tax amount paid might be the same or even higher. The conclusion- why not pay the tax now, contribute to your TFSA and forget about any future taxation on this money and reduction on government benefits and tax credits.

    1. @Elemag,

      You are always very kind with your comments.

      I definitely think individual taxes will go up over time, and corporate taxes will go down. That’s just me. If my prediction is correct however, the TFSA will win for many. Not to mention, for all the sound, practical reasons you listed as well.

      If you can avoid paying any taxes now, it is best to do so. Thanks for reading.

  9. Hey FG!

    Yeah – I took a break from LiveFyre because I got some nasty spam comments on my site with it. I hope not too many people saw them. I tried to delete them ASAP!

    Seems Akismet is working much better. I will be emailing Livefyre to find out how to correct that, if I choose to activate the plugin again.

    Can’t you email me often and we can follow each other on Twitter for real-time updates? 🙂

  10. Dave The TFSA is a much better option in many ways, for one thing any withdrawals are not taxed. In addition those withdrawals won’t be added to your income, or affect your government benefits, etc. The TFSA is a really good deal!

    Actually I believe it is the other way around – if you have higher income you benfit more from the RRSP since you are in a higher tax bracket and get a larger refund. The TFSA is a perfect solution for people who are not high income earners. I think once you actually look into the TFSA, you will find it is a great way to save for retirement.

    It’s up to people to make the effort to save whether its a TFSA or RRSP. If there are other reasons you are not saving, then its important to address those first. Unfortunately the TFSA has been poorly marketed which prevents people understanding the full benefits.

    The Dividend Ninja

  11. On that TFSA soap box again ah Mark. Just kidding. I do understand the benifits, but as you said, they are not for everyone. I would argue that the only people who can really benefit are those who make good money and those with a lot of disposable income. I think the rrsp model tends to force people to save a little easier because contributing tends to be more structured. Also, it’s harder to get the money out prematurely. The money isn’t as available, which is probably a good thing in many cases.

    1. @Dave,

      Yeah, I am 🙂

      Thanks for your comment.

      I see the TFSA as a gift for everyone really. RRSPs only make sense for some people and not even, if you’re not careful with that tax refund with the RRSP.

      For low-income earners, they should be using it because RRSPs don’t make sense for them. They are already paying little tax now, they will only have to pay tax on the RRSP withdrawal later in life. They are adding to their tax burden.

      For middle-income earners, the TFSA helps since although there is no tax contribution refund up-front, the nature of the account shelters tax permanently. This case can be made for all wage earners.

      For high-income earners, for sure the RRSP helps thems now but the taxes will come back to haunt them, unless they are paying much more tax now than in retirement. For very high-income earners, the benefits of the RRSP probably might trump the TFSA because of the present value tax refund.

      Regardless of what you make in wage and what you contribute, $50 per year, $500 per year, $5,000 per year, tax-free compound growth and tax-free withdrawals are an outstanding exemption.

      The RRSP model definitely is more forced savings, but I’d argue there are more incentives to contribute to the RRSP – tax refund – which is really a temporary government loan.


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