Wednesday, February 3, 2010

RRSP versus TFSA

Much has been made of the C.D. Howe report on the tax effectiveness of RRSPs and TFSAs. As Canadian Capitalist’s summary of the report explains, the nod goes to TFSAs over RRSPs much of the time, particularly for lower-income Canadians. However, the analysis for a given individual is often much simpler.

The limits placed on contributions to RRSPs and TFSAs can make the choice easier for some people. Let’s look at a few cases.

Case 1: Low income

As the C.D. Howe report shows, most lower income Canadians are better off with savings in a TFSA than an RRSP. If by some miracle a low-income earner has more savings left after maxing out his TFSA, he can contribute to his RRSP. That case was easy.

Case 2: High income

It’s nearly impossible to achieve the income replacement rates in retirement used in the C.D. Howe report without using both RRSPs and TFSAs. This makes the whole discussion moot. If contribution room were unlimited, then it would be worth debating whether high income earners should contribute to one or the other.

Case 3: Middle income

Middle income earners are also better off if they use both their RRSPs and TFSAs. Often this is impractical though, because these people are unable to save this much money. So, these are the Canadians who need to pore over the C.D. Howe report to make their choice.

By showing that TFSAs are of greater value than RRSPs to a wide range of Canadians, it could be that C.D. Howe is preparing to make the argument that TFSA room should be greatly expanded. This is just speculation on my part, but it’s hard to see the point of most of their analysis otherwise.


  1. Since they first announced the TFSA, I've always thought it should have a much larger annual contribution limit. I vote for that option.

  2. Canadian Investor: I'd want to see what other tax gets increased to compensate for the lost tax revenue due to increasing TFSA limits before I embrace higher TFSA limits. Sadly, there is no free lunch, especially for taxpayers.

  3. I think TFSA can take RRSPs, because it is younger, and will use either the Big Splash or the People's Elbow to finish off the old and weak RRSP.

  4. Big Cajun Man: After listening to some people talk about RRSPs and TFSAs, I think they might understand your explanation of the choice better than they would understand mine. Knowledge in this area among the general public seems very limited.

  5. I agree with your analysis. At this point, all except the lowest earners need both. I wrote about this as well yesterday, and I believe the report does argue that TFSA room should be expanded in the "Conclusion and Policy Implications" section.

    I also agree that the details of this debate are lost on many Canadians. Judging by some of the searches I receive on my site, there is a need for more basic education on RRSPs, TFSAs, and the difference between the two.

  6. Thanks for the mention Michael. Middle income households could alternate between the two, contributing to the TFSA in some years and the RRSP in others. This debate would never get settled because there are so many unknown variables.

    I don't fall in the camp that TFSA room should be hiked. Royal Canadian Air Farce did a skit on this that goes along the lines of "yeah, as if we have enough money to contribute to a RRSP in the first place!". There is a lot of truth to that.

  7. TFSAs are definitely the way to go for most young investors. RRSPs are great once people are established.

  8. I don't think hiking TFSA room should be a priority either. Those of us whose problems consist of not enough room to shelter retirement savings are lucky compared to most other Canadians. The least fortunate among us deserve government help before the most fortunate.

    Also, in ten years, everyone will have $60,000 in TFSA room, in twenty years, $110,000. Five thousand per year eventually adds up to a significant amount.