Business owners have far more options available to them they may realize. The question may not be whether TFSA or RRSP but instead, what is the best investment vehicle for business owners? TFSAs are available regardless of income, that is they don’t need T4 income to qualify. Therefore dividend income which doesn’t qualify as T4 income is eligible to be deposited into a TFSA which has a cumulative total of $69,500. The bigger question may be whether to contribute to an RRSP or an IPP (Individual Pension Plan). If you are an owner of an incorporated business and take T4 income, you may want to explore an IPP as a better option. Here is another post that goes into greater detail about the IPP.
Today, one of the most common investment questions Canadian business owners ask themselves today is, “Which is better, TFSA or RRSP”?
Here’s the good news – it doesn’t have to be an either-or choice. Why not do both? Below are the features of both plans to help you understand the differences.
Tax-Free Savings Account (TFSA)
- Any Canadian resident age 18 or over may open a TFSA. A contribution is not based on earned income. There is no maximum age for contribution.
- The maximum contribution is $5,500 per year. In 2015, the maximum limit was briefly increased to $10,000, but the change of government has resulted in restoring the previous maximum and increased the amount in 2019 and 2020, to $6,000 per year.
- There is carry forward room for each year in which the maximum contribution was not made. For those who have not yet contributed to a TFSA, the cumulative total contribution room as of 2020 is $69,500.
- The deposit is not tax-deductible, but the funds accumulate with no income tax payable on growth.
- Withdrawals may be made at any time on an income tax-free basis. Withdrawals create additional deposit room commencing in the year after withdrawal.
Registered Retirement Savings Plan (RRSP)
- No minimum age for contributing, but must have earned income sufficient to generate RRSP contribution room.
- The maximum contribution is 18% of earned income based on your previous year’s earnings to a maximum of $26,500 (for 2019). The maximum contribution for 2020 is $27,230.
- There are carry forward provisions for years, not contributing.
- A contribution is tax-deductible from earned income, and the funds accumulate on a tax-deferred basis.
- All withdrawals are taxable as income at the top rate of tax based on earnings in the year of withdrawal.
- RRSP ends in year contributor turns age 71, when the RRSP must be converted to a Registered Retirement Income Fund (RRIF) or life annuity and taxable income is taken.
The advantages and disadvantages of both
- Both programs provide for no tax on the earnings on the contributions, no difference there; however, only the TFSA allows for tax-free withdrawals.
- A good habit to get into is to reinvest the tax savings from your RRSP contribution. This maximizes your retirement savings with additional tax-deferred growth.
- Or you might want to consider using your tax savings or refund created by your RRSP contribution to fund your contribution to your TFSA.
- Be careful not to overvalue your RRSP balance. The total value of your RRSP will be reduced by the tax payable upon withdrawal. Tax is also payable upon death if the beneficiary is anyone other than a spouse.
- RRSP works best for those people who will retire in a lower tax bracket.
The bottom line?
Unless the tax savings from the RRSP are routinely reinvested, at the end of the day, there is little or no difference between the results of a TFSA or an RRSP.
Want maximum results? Take your RRSP tax savings and reinvest it to have a great impact on your retirement savings.
- If you invest $5,000 per year in an RRSP for 20 years at 5% compound growth, tax-deferred at the end of 20 years you will have $173,596.
- If you were to invest the $1,750 tax savings (based on a 35% tax bracket) for 20 years, your RRSP would grow to $234,355. That is an additional $60,759 in your retirement savings!
- Of course, you could choose to reinvest the RRSP tax savings of $1,750 in a TFSA where it will accumulate tax-free to the same $60,759 but the advantage here is you can withdraw this without tax.
Please call me if you want to discuss how you can optimize the use of both of these retirement vehicles. As always, feel free to use the share button to share this article with a friend or family member.
Chris Coulter is the Founder and President of The Finish Line Group. He works with business owners to leverage their businesses to increase their wealth, reduce corporate and personal taxes, create viable succession strategies, enable employee retention strategies and allow them to exit their businesses on their terms.
Chris’ passion for what he does evolve from the mistakes he made in his first business; by not diversifying his risk and not utilizing a lot of the opportunities within his business to create significant wealth. Chris found out the difficult way and now educates business owners on how to avoid many of his former oversights and ultimately control where their finish line ends.
TFSA or RRSP