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

Last updated: Nov. 28, 2022 

If you’re self-employed or a small business owner, saving for retirement comes with its own set of challenges:

  • You don’t have access to an employer-funded savings plan
  • You’re putting as much of your own money into the business as possible
  • You’re so focused on growth that saving for retirement gets pushed to the bottom of your priority list

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

Are you investing in a registered retirement savings plan (RRSP) or tax-free savings account (TFSA)?

If you’re not, you’re missing out on tax savings.

But you might be wondering, should I use an RRSP or TFSA?

The answer is both if possible – and you should max them out as much as you can.

But depending on your tax bracket and when you need the money, you might want to choose one account over the other.

We go over the key differences between an RRSP and TFSA to help you determine which one is right for you.

Should I contribute to an RRSP?

RRSPs are a tax deferral mechanism. Contributions to an RRSP are deductible against your current income so you receive immediate tax relief and tax-sheltered growth. When you eventually go to withdraw the money in your retirement, it’s taxed at that time when you are paying lower taxes.

To maximize the benefits of the RRSP, you should contribute to it when you’re in a higher tax bracket and withdraw from it when you’re in a lower tax bracket. Contributing to an RRSP can significantly bring down your taxable income.

Let’s look at an example:

  • You make $120,000 in 2021 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 tax deductible
  • You pay tax on the contribution in the year you withdraw it, so 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 an RRSP?

First, it is important to understand the difference between your deduction limit and your contribution limit:

  • Your deduction limit is the amount you’re permitted to put into your RRSP and use as a deduction on your income tax report. For the 2022 tax year, it is up to 18% of your reported 2021 income (to a maximum of $29,210, whichever is less).
  • Your contribution limit is equal to the current year’s deduction limit plus any unused deduction room from previous years.
  • Since most people do not 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 (as calculated above) applies to all of them combined.

Here’s an example:

  • Mary’s full-time, pre-tax employment income in 2021 was $80,000. Her maximum deduction limit for the 2022 tax year would be calculated as follows:
  • $80,000 × 18% = $14,400 (less than the maximum limit of $29,210)
  • Mary can deduct up to $14,400 through her RRSP contribution for the 2022 tax year
  • If Mary contributes $6,000 to her RRSP for 2022, she’ll have $8,400 that she can carry forward in contribution room for the 2023 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 2022, review your latest notice of assessment or notice of reassessment.

You can also find it on a T1028 form, which the Canada Revenue Agency (CRA) sends you if there were changes to your RRSP deduction limit since your last assessment.

The RRSP contribution deadline will vary based on the year; however, it will always be 60 days after December 31 of the taxation year.

What is 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 December 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 contribute to a spousal RRSP to help even out retirement savings for you and your spouse if they earn a lower income, since contribution room is based on earned income.

Your spouse would open a spousal RRSP account in their name (separate from their personal RRSP account), and you could contribute to the spousal RRSP.

Be careful not to go over your RRSP contribution limit – if you max out your RRSP, you can’t contribute to the spousal RRSP.

When your spouse withdraws the money in retirement, they’ll pay the tax on the withdrawals at their lower tax rate.

Read more on converting an RRSP to an RRIF.

Should I contribute to a TFSA?

Tax-Free Savings Accounts (TFSAs) don’t give you up-front tax relief, but your money accumulates tax-free, and you won’t be taxed on withdrawals.

You can use your TFSAs for investments like Guaranteed Investment Certificates (GICs), stocks, bonds, or mutual funds. Any investment income earned through in your account, and 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 TFSA contribution room each year (from 2009) even if you do not file a tax return or open a TFSA. You can also withdraw from your TFSA at any time, and withdrawals free up more contribution room for you in the future.

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

If you go over your accumulated TFSA contribution limit, this excess amount will be subject to a 1% per month penalty tax for as long as that excess amount remains in your account. For example, if you over contribute $3,000 in a year, you will pay $30 per month, every month you remain in excess – that’s $360 in penalties in one year alone.

Learn more about TFSAs and the 2023 contribution limit here.

Is an RRSP or TFSA better for me?

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

  1. What is your current tax bracket?
  2. What do you think your tax bracket will be in the future? Will you have any additional retirement income or benefits, like an employee pension?
  3. When do you think you will need the income, in retirement or in the near future?
  4. Could your federal and/or provincial incomed-tested benefits like Old Age Security (OAS) be affected?

Most people are in a higher tax bracket during their employment years. If this applies to you, investing in an RRSP is your best bet to take advantage of a reduced tax rate when you withdraw the money.

If you’re saving for a vacation or a down payment on a home, a TFSA will allow you to contribute up to $6,000 per year in a tax-sheltered investment, free to withdraw at any time.

Below are some scenarios that may help you.

  • A TFSA should be funded first, since you are in the lowest tax bracket and reducing your taxable income won’t further lower your tax rate.
  • In this case, your tax rate approaches 40%, therefore investing in a RRSP will benefit you the most by bringing down your taxable income.
  • You may want to consider funding your RRSP and TFSA equally until you max out your TFSA.

When should I contribute to an RRSP first?

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

When should I contribute to a TFSA first?

  • 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’ll pay when you take it out later.
  • If you think you might need the money before retirement age, TFSAs are more flexible, and you won’t pay any taxes upon withdrawal.
  • If you’re in retirement, and you’re close to your Old Age Security claw back amount, consider withdrawing more money from your TFSA as opposed to your RRSP as these amounts won’t be added to your income.

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

A comparison of RRSPs and TFSAs

 

RRSP

TFSA

Purpose

  • Primarily to save for retirement
  • Can also be used to:
  • Save for any purpose

Annual Limit

Deduction limit is the lesser of (for 2022):

  • 18% of previous year’s (2021) reported income
  • Maximum $29,210/year

Contribution limits

  • $6,000 (2022)
  • $6,500 (2023)
  • 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 years contribution limit plus the current year’s deduction limit
  • You can invest your entire unused contribution amount any time

Contribution Deadline

  • March 1, 2023
  • Contribution limits are based on a calendar year

Impact on Taxes

  • Tax deductible (up to limit)
  • Not tax deductible

Withdrawals and Reporting

  • Taxed on Withdrawal at marginal tax rate applicable at time of withdrawal
  • Must report as income on tax return
  • Earnings are not 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 December 31 of the year you turned 71
  • Must start withdrawals by age 71 or open an RRIF (Registered Retirement Income Fund)
  • Does not mature

Spousal Plan

  • You can contribute directly to a spousal RRSP
  • Not applicable 

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