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RRSP or TFSA? How they contrast and compare as life circumstances change

Phil and Anne Haylock run a heating, air conditioning and ventilation business in Oshawa, Ont. Their retirement saving strategies have changed since Phil left General Motors after 30 years and started a small business.

Chris Young/The Globe and Mail

When Phil Haylock retired from General Motors of Canada Co. in 2015 after nearly 31 years of service to move into a new career as a small-business entrepreneur, he also adjusted his primary retirement savings strategy.

Instead of contributing mainly to a registered retirement savings plan (RRSP) he is now concentrating more on his tax-free savings account (TFSA).

"RRSPs were really good when I was a high-wage earner at General Motors and they saved me tax when I made the contribution. Today, as an entrepreneur, I favour TFSAs because it's all after-tax money that's put in, and my investments accumulate tax-free. That's a pretty awesome thing," says Mr. Haylock, 56, who runs a heating, air conditioning and ventilation business in Oshawa, Ont., with his wife Anne, 54.

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Ms. Haylock also has RRSP and TFSA instruments in her retirement portfolio.

Both spouses realize what many Canadians have learned since TFSAs were introduced in 2009 for ages 18 and up – that a well co-ordinated retirement savings strategy can include both RRSP and TFSA instruments.

Shelley Johnston, an investment planning counsellor and partner with Pension Specialists Inc. in Whitby, Ont., is their adviser.

"In a perfect world, one would max out [both] their RRSPs and their TFSAs. However, we all know we don't live in that perfect world," says Ms. Johnston, referring to record high personal debt levels that Canadians have racked up in lieu of saving for their future.

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Experts also point out how financial and other daily living constraints often prevent many Canadians from being able to save the maximum annual amount they are allowed in these instruments, which is 18 per cent of the previous year's earned income for RRSPs and $5,500 for TFSAs.

For some Canadians, it may be practical to prioritize either an RRSP or a TFSA, based on the way each of these registered plans is structured.

When money is contributed to an RRSP, the contributor is eligible for an up-front tax deduction to reduce taxes payable, which might also involve a tax refund.

"It's one of the most generous tax incentive accounts in the world," says Jason Kingston, a principal with accounting firm DSK LLP in Kitchener, Ont. "The investment earnings within the RRSP umbrella accounts grow tax deferred. You can invest in just about anything within the RRSP that you could outside of the RRSP – so mutual funds, stocks, bonds, or just straight savings accounts."

An RRSP can be held until the end of the calendar year in which a taxpayer reaches 71, when the proceeds must be converted into either a registered retirement income fund (RRIF) or an annuity. The RRIF has a mandatory withdrawal schedule starting the year the taxpayer turns 72. When a RRIF withdrawal or annuity payment is made, that amount is then taxable.

In contrast, TFSA contributions are made with after-tax money. There is no tax deduction when a contribution is made, and there are no tax consequences when funds are withdrawn. The investments held within a TFSA are essentially the same as allowed within the RRSP, and they grow tax free within the account.

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"A TFSA is a little bit more flexible in that you can put it in for the short term and know that taking it out won't be a tax hit for you," says Heather Wright, a partner in tax services at Ernst & Young LLP in London, Ont.

For example, experts note the TFSA could be beneficial to entrepreneurs who need to maintain a cash flow for their business.

The TFSA structure is also often cited as being advantageous to people who are just starting their careers.

"Young out of the gates, I would say TFSA. Probably they're not earning that much yet. So the tax deduction of the RRSP is likely to be better served in later years when their incomes are higher and their marginal tax rates are higher," Mr. Kingston says.

When money is put into the RRSP and has to be withdrawn, in most cases it is a taxable withdrawal [notable exceptions being the allowable housing and education withdrawals which have specified payback times] and the contribution space is forever lost. But with the TFSA, money can be withdrawn and then within or after the next calendar year, it can be recontributed if the funds become available, Mr. Kingston explains.

"I find with a lot of our younger generation, they don't have a lot of disposable income. They've got debt or they don't have emergency savings. So I'm saying for young adults, let's start the TFSA," says Ms. Johnston.

"Let's start off where we have $1,000 set aside as a short-term emergency fund. Because we know life happens. Within a TFSA it's earning the interest that's tax sheltered," she adds.

For somebody in their prime earning years, the benefits of contributing to an RRSP, including an up-front tax deduction, the opportunity to earn investment income on a tax deferred basis from a variety of instruments, along with a chance to defer withdrawal until retirement when the taxpayer is presumably going to be in a lower marginal tax bracket, might provide the best bang for their buck.

But there are also some strategies which allow contributions to both types of registered accounts.

"So ideally, if any of my clients that are in a higher tax bracket are putting RRSP money aside and don't have enough to max out their TFSAs each year, they are now trained that when they get that tax refund, it goes into the TFSA so they are saving for tomorrow," Ms. Johnston adds.

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