Should I use an RRSP or TFSA as a business owner?

Last updated: Jan. 26, 2024 

If you’re self-employed or a small business owner, saving for retirement comes with a unique set of challenges, which may include: 

• You lack access to an employer-funded savings plan.
• You’re putting as much of your own money into the business as possible. 
• You’re extremely focused on the growth of your business, and saving for retirement just isn’t a priority. 

However, there are simple things you can do right now that can make a difference to your retirement savings.

TFSA vs. RRSP: Which is the better option? 

Are you investing in a tax-free savings account (TFSA) or registered retirement savings plan (RRSP)? If you’re not, you’re likely missing out on tax savings. However, you may be wondering if you should use an RRSP or TFSA.

The answer? Both, if possible. And you should max them out as much as you can. However, depending on your tax bracket and when you need the money, one account may offer more advantages over the other.

Both are popular types of investment accounts in Canada. Each offers unique features and advantages. Overall, the main difference between an RRSP and TFSA is the timing of the tax benefit.

Should I contribute to a Canada RRSP?

An RRSP is considered a tax deferral mechanism. Contributions made to an RRSP are deductible against your current income, allowing you to receive immediate tax relief and tax-sheltered growth. When you eventually withdraw the money in this account, it’s taxed at that time—when you’re paying lower taxes.

To maximize RRSP benefits, you should make contributions when you’re in a higher tax bracket. Then, you should make withdrawals when you’re in a lower tax bracket. Contributing to an RRSP can significantly bring down your taxable income.

Here’s an example:

• You make $120,000 in 2023 and contribute $15,000 to your RRSP. 
• The CRA will tax you on $105,000 of income instead of $120,000 since the contribution is deductible.
• You pay tax on the contribution in the year you withdraw it. If you take out some of the money in your retirement when you have a lower income, you’ll pay less tax. 

How much can I contribute to a Canada RRSP?

First, it’s important to understand the difference between your deduction limit and your contribution limit.

Your deduction limit is the amount you can put into your RRSP and use as a deduction on your income tax report. For the 2023 tax year, it’s up to 18 percent of your reported 2022 income. For 2022, the limit was $29,210. For 2023, the RRSP deduction limit is $30,780. 

Your contribution limit is equal to the current year’s deduction limit plus any unused deduction room from previous years.

Since most people don’t contribute the maximum amount to their RRSPs every year, your deduction limit will be much lower than your contribution limit.

If you have multiple RRSPs, including one for a spouse, your deduction limit applies to all of them combined.

Let’s take a look at an example:

Mary’s full-time, pre-tax employment income in 2022 was $80,000. Her maximum deduction limit for the 2023 tax year would be calculated as follows:

• $80,000 ✕ 18 percent = $14,400 (less than the maximum limit of $30,780)
• Mary can deduct up to $14,400 through her RRSP contribution for the 2023 tax year.
• If Mary contributes $6,000 to her RRSP for 2023, she’ll have $8,400 that she can carry forward in contribution room for the 2024 tax year. Assuming her deduction limit stays the same, she will be able to contribute a total of $22,800 ($14,400 +  $8,400).

To find out your contribution room for 2023, review your latest notice of assessment or notice of reassessment.

You can also find this information on a T1028 form, which the Canada Revenue Agency (CRA) sends you if your RRSP deduction limit changed since your last assessment. The RRSP contribution deadline will vary based on the year, but it will always be 60 days after Dec. 31 of the taxation year.

What’s the age limit for contributing to an RRSP?

The RRSP must be fully withdrawn or transferred to a registered retirement income fund (RRIF) or annuity by Dec. 31 in the year you turn 71. Otherwise, the CRA will include the entire amount of your RRSP in your taxable income that year.

Contributing to a Spousal RRSP

You can also make contributions to a spousal RRSP to help even out retirement savings for you and your spouse as long as your partner earns a lower income. This is allowed because contribution room is based on earned income.

To accomplish this, your spouse should open a spousal RRSP account in their name separate from their personal RRSP account, and then you can contribute to the spousal RRSP.

When your spouse withdraws the money in retirement, they’ll pay taxes on any withdrawals made at their lower tax rate. However, avoid exceeding the RRSP contribution limit. If you max out your RRSP, you can’t put money into your spouse’s account. 

Read more on converting an RRSP to an RRIF.

Should I make contributions to a TFSA vs. an RRSP?

TFSAs don’t offer up-front tax relief, but your money accumulates tax-free, and you won’t be taxed when making withdrawals.

You can use your TFSAs for investments such as guaranteed investment certificates, stocks, bonds, or mutual funds. Any investment income earned through your account—along with capital appreciation from stocks and bonds—is tax-free.

Unlike an RRSP, you don’t need earned income to accumulate the contribution room in your TFSA. You will accumulate a TFSA contribution room each year (from 2009) even if you don’t file a tax return or open a TFSA. You can also withdraw funds from your TFSA at any time. Withdrawals free up more contribution room for you in the future.

There’s technically no deadline to make contributions to your TFSA. If you haven’t maxed out your TFSA, you can carry any unused contribution room into the next year because it’s carried forward on Jan. 1.

If you surpass your accumulated TFSA contribution limit, the excess amount will be subject to a 1 percent per month penalty tax for as long as that excess amount remains in your account. For example, if you overcontribute $3,000 in a year, you will pay $30 per month for every month you remain in excess. That equals $360 in penalties from a single year. 

TFSA vs. RRSP: Which is the better option for me?

There are a few questions you should ask before choosing between these two options:

• What’s your current tax bracket?
• What do you think your tax bracket will be in the future? Will you have any additional retirement income or benefits, such as an employee pension?
• When do you think you will need the income: during retirement or in the near future?
• Could your federal and/or provincial income-tested benefits, such as Old Age Security (OAS), be impacted?

Most people fall into a higher tax bracket during their employment years. If this applies to you, investing in an RRSP is your best bet. If you’re saving for a vacation or a down payment on a home, a TFSA will allow you to contribute up to $6,500 per year in a tax-sheltered investment, which you’re free to withdraw at any time.

Below are some scenarios that may be helpful to consider when making your decision: 

• If you’re earning less than $50,000: You should fund a TFSA first because you’re in the lowest tax bracket, and reducing your taxable income won’t further lower your tax rate.
• If you’re earning between $50,000-$98,000: You may want to consider funding your RRSP and TFSA equally until you max out your TFSA.
• If you’re earning more than $98,000: In this case, your tax rate approaches 40 percent. Investing in an RRSP will benefit you the most by reducing your taxable income.

When should I contribute to a TFSA vs. an RRSP?

If you have a matching contribution retirement or pension plan with your employer, maximize your contributions before considering a TFSA.

If you think your income after retirement age will be greater than what you earn now (i.e., you have a pension or some other retirement income), your money should go into your TFSA first. It’s better to pay the lower income tax rate on that money now than the higher rate you would pay if you withdraw it later. 

If you believe that you may need the money before retirement age, TFSAs offer more flexibility, and you won’t pay any taxes upon withdrawal. And once you’re in retirement and close to your OAS clawback amount, consider withdrawing more money from your TFSA because these amounts won’t be added to your income.

If possible, it’s a good idea to make contributions to both accounts. If you contribute to each account every year and then invest the money, you’ll make a big difference in your retirement savings.

	RRSP	TFSA
Purpose	Mainly used to save for retirement Can also be used to: Finance your first home under the government’s Home Buyer’s Plan. Save for education for yourself or your spouse under the government’s Lifelong Learning Plan.	Save for any purpose
Annual Limit	Deduction limit is the lesser of (for 2023): 18% of previous year’s (2022) reported income Maximum $30,780/year	Contribution limits $6,500 (2023) $7,000 (2024) Plus leftover contribution room from previous years up to your maximum cumulative amount
Unused Contribution	You may contribute amounts up to and including your previous year’s contribution limit plus the current year’s deduction limit.	You can invest your entire unused contribution amount at any time
Contribution Deadline	February 29, 2024	Contribution limits are based on a calendar year
Impact on Taxes	Deductible (up to a limit)	Not deductible
Withdrawals and Reporting	Taxed on withdrawal at marginal tax rate applicable at time of withdrawal Must report as income on tax return Earnings aren’t tax sheltered Contribution room is lost for amounts you withdraw	Not taxed on withdrawal; your contributions are made from net income Not reported as income tax on tax return Earnings are tax sheltered Withdrawn amounts are added back to your contribution room for the following year No minimum withdrawal requirements
Plan Maturity	Matures Dec. 31 of the year you turned 71 Must start withdrawals by age 71 or open an RRIF	Doesn’t mature
Spousal Plan	You can contribute directly to a spousal RRSP	Not applicable

 

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