Thursday, March 1st, 2018
Q: Should I contribute to a TFSA instead of an RSP?
A: The launch of Tax-Free Savings Accounts (TFSAs) in 2009 opened up a whole new world of financial decision making for Canadians. Most people I speak with are big fans of TFSAs, while there seems to be a growing number who are also quite negative about RSPs. But as with most personal finance decisions – there's no one-size-fits-all when it comes to TFSAs vs. RSPs.
It appears that the (relatively) new kid on the block – the TFSA – has won the popularity contest for the account registration type of choice. Data from the Office of the Superintendent of Financial Institutions (OSFI) showed that 30% of Canadian taxpayers contributed to a TFSA in 2015, with 23% of taxpayers contributing to an RSP. That's nearly 8 million Canadians contributing to a TFSA, and only 6 million contributing to an RSP.
It's not all bad news for RSPs, though. While TFSA use is increasing across the board, RSP use is still holding steady among older, wealthier Canadians, with an increase in use for those making between $60,000 and $80,000 a year. TFSAs are most popular for lower-income, younger Canadians. And it makes sense. When you're in a lower income tax bracket, you don't benefit nearly as much from the RSP's tax deduction for your contributions. And if you're in a lower tax bracket, you'll likely be in a higher one at retirement, which is where TFSAs provide the biggest benefit over RSPs. That's because TFSA withdrawals are tax-free, and RSP withdrawals are taxed.
One of the reasons why Canadians love TFSAs is their flexibility. That is, it's easy to withdraw – and without having to pay tax. Statistics Canada has reported that approximately half of all money deposited into a TFSA in a given year is withdrawn. The frequency of withdrawals from TFSAs is much larger than it is for RSPs. And this makes sense, even if it's not ideal behaviour. Withdrawing from an RSP almost always has consequences, so casual withdrawals aren't the norm – they're the exception. The only times where tax-free withdrawals are allowed from RSPs is for either the Home Buyer's Plan (HBP) or Lifelong Learning Plan (LLP), and even these have strict rules around repayment of the amount borrowed.
If TFSA use is increasing and RSP use is declining, are Canadians just redistributing harder-to-access RSP contributions into easier-to-access TFSA accounts? Does this mean less money is being saved overall for retirement, since more is going into easier-to-access TFSAs rather than into harder-to-access RSPs? Is a significant amount of it then withdrawn and spent because there's aren't any real consequences for withdrawing? I certainly hope not, but the data does seem to suggest some of this is happening…
Even though I, too, love TFSAs for both short and long-term goals, the RSP is still my go-to account type for retirement savings. Personally, I find the withdrawal penalties for RSPs are so steep that most people don't access their RSPs outside of the HBP, the LLP or an extreme emergency. This is in contrast to the amount of TFSA money that is contributed and then withdrawn each year. It's just human nature – make it easy for me to withdraw, I'll take advantage; penalize me for it, I'll be less inclined to do so. Our own behaviour is often our worst enemy when it comes to personal finance decisions, and that's why I hope TFSAs are used in conjunction with RSPs, not in place of them.
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This article is intended to provide general information only about RSPs and TFSAs. If you need further information about your specific circumstances you should speak to an investment advisor.