Overcontributing will result in a penalty of 1% each month of the excess amount.

Residents born in 2002 or later will not be able to contribute the maximum TFSA room. Check your eligible TFSA room on your CRA account.

When you make a withdrawal, you can contribute back that amount on January 1st of the following year. You do not lose your contribution room as you do in an RRSP.

Since 2009, the TFSA has become the more popular choice as people began to become more knowledgeable about the TFSAs features. The TFSA provides exceptional withdrawal flexibility because withdrawals are non-taxable and contribution room is lost only until the next January 1st. Withdrawals are also not income tested which again presents its advantages in retirement particularly when planning around Old Age Security.

One of the biggest questions clients have is about RRSP or TFSA. Which one is best for me?

Some advisors will spend hours and dive into analytical scenarios of your possible future to figure this out. I find that the answer to the question is better solved with a combination of math and lifestyle flexibility. I will show you what I mean down below.

Often, clients can’t afford to contribute the maximum in both savings vehicles so it becomes a choice either or; or a combination of the two.

The biggest reason people would choose to invest in an RRSP is when they think they will require less money in retirement than while they are working.

If your income in retirement is going to remain close to the same as it is now, you lose the real benefit of RRSPs. You may as well save yourself the headache of getting a tax break now only to give it right back in retirement.

This is very well the case for people earning less than $106,717*. At this income level, the Federal Tax Rate jumps from 33% to 38.5%. This 5.5% jump is the largest increase in any of the federal tax rates (ignoring the basic tax exemption levels).

For people earning less than $106,717 the tax savings if you contribute to RRSP will be so minimal that you may as well save yourself the time and contribute to your TFSA. Remember that TFSA withdrawals are non-taxed and are not income tested for Old Age Security benefits.

You could park your emergency funds and money for major purchases in your TFSA if you have the contribution room AND it won’t delay your retirement. I hate to see clients get in the habit of using their TFSA savings for major purchases and emergency accounts because that will inevitably delay retirement. The easy access to money is potentially one of the drawbacks of the TFSA.

However, if you have the contribution room and your savings funds are limited, you could kill three birds with one stone by focusing all your savings to your TFSA.

One way you could separate the funds is by allocating the money into three separate investments. One for retirement, one for a major purchase, and one for emergencies. That way you can avoid dipping into your retirement savings

Many people build up large defined contribution pensions or will benefit from high-income defined benefit plans. It’s not unreasonable to have $750,000 in your defined contribution pension if you have been a loyal employee. It is also not unreasonable to have a defined benefit plan paying you $55,000/year for life.

Both of these situations are great but it does lead to a tip-toe dance to keep retirement incomes under the OAS threshold. For 2023 that threshold is $86,912 of income per year. Sometimes going over this is unavoidable but as retirement planners, we try and get the maximum out of government benefits as possible. Pair your pension income with extra savings in RRSPs, and the task becomes a real challenge.

Example:

Which retirement portfolio would you rather have?

Portfolio 1- $750,000 Defined Contribution Pension & $250,000 RRSP
Portfolio 2- $750,000 Defined Contribution Pension & $250,000 TFSA

The answer is Portfolio 2 will only have $750,000 in taxable assets versus $1,000,000 in Portfolio 1. Portfolio 2 will make it easier to stay under the OAS threshold.

Also, there is nothing worse than wanting to go on a vacation in retirement and having to take out $10,000 in RRSP just to net $7,500 after taxes.

NOW, this is a severe oversimplification but remember that this is the non-technical version as stated in the title.

Just as in the previous example in pension planning, the TFSA can also help lower your estate tax bill. Remember that on the second death of a spouse, taxes have to be paid on the remaining assets in the estate.

In some situations, we suggest you withdraw a higher income from the RRIF or PRIF and contribute the excess money into a TFSA. This strategy works when the client has a TFSA room and excess registered assets that they don’t plan on using.

What you are effectively doing is reducing the potential estate taxes in the event of early death.

This scenario is more of a personal preference of mine.

I like to use the TFSA when helping clients save for a down payment on a home rather than the Home Buyers Plan.

The Home Buyers Plan allows first-time home buyers to withdraw up to $35,000 from their RRSP to buy a house for themselves. Click here for all HBP rules. Then, the home buyer can repay the amount they withdrew over the next 15 years. Essentially a loan to themselves.

There are two problems here. One, now that you have purchased your home, you have most likely increased your cost of living with a new mortgage, taxes and utility costs- making it difficult to repay your HBP.

The second problem is because you contributed your down payment savings to your RRSP, you have locked in your tax deduction rate at the time you contributed. Many first-time home buyers are in entry-level jobs and expect their income to grow over time. It makes more sense to save your RRSP room for when your income increases- preferably higher than $106,717*.

As always, make sure you consult with a Certified Financial Planner to review your situation. These scenarios are common scenarios that I run into and should help you get some clarity on when to choose to save in your TFSA versus your RRSP. The best scenario is to do both!