I know I’ve written about this before, but this is a topic that needs to be addressed regularly because the answer is always different depending on your age, income, and financial personality! It’s not always easy to know if you should contribute to an RRSP or a TFSA, but there are some clear rules of thumb to follow.
As of January 1, 2015 the TFSA contribution limit grew by $5,500 to a total of $36,500 for anyone over the age of 18 as of 2009. If you came of age after 2009, you have $5,000 to $5,500 less in contribution room for each year you missed. No worries though, you can contribute to a TFSA until you’re dying day, so you have a lot of time to catch up!
The RRSP limit is 18% of your gross income each year, to a maximum of $24,270 for 2014 (you would have to earn over $130,000 last year to get this). Since RRSP contribution is determined by your income, and the limit traditionally increases each year, how much contribution room you have is unique to you and your personal income history. You can begin contributing to an RRSP as soon as you get your first job, even if you are under the age of 18, but you have to stop contributions at age 71.
You can view your RRSP contribution room on your Notice of Assessment when you file your income taxes, or on the Canada Revenue Agency website. You can also check your TFSA contributions and room on the Canada Revenue Agency website, though these aren’t always up to date. It is worthwhile to keep your own records for each account to ensure accuracy.
Should You Contribute To An RRSP or TFSA?
What most people struggle with in their 20s, however, is not how much they’re allowed to contribute to each account, but which account they should contribute to in the first place.
Many Canadian personal finance websites and blogs will insist the rule is always to max out your TFSA first, before you start contributing to an RRSP. For many 20-somethings this is good advice, because their incomes are typically low and they want to have ready access to their savings. However, if your income is above $50,000, which account is best for you gets a little murkier. Below is some general guidelines for contributions to a TFSA, RRSP and unregistered accounts based on your income.
If your income is less than $50,000 per year, contribute only to a TFSA until it’s maxed out.
There’s no point in contributing to an RRSP on a small income if you still have contribution room in your TFSA. It doesn’t do anything for your tax-wise, and you likely can’t afford to aggressively tackle RRSP contributions after you max out your TFSA. It’s in your best interest to treat your TFSA as a retirement savings vehicle rather than a revolving-door savings account, so even though you can save for items like a house downpayment or a wedding within the TFSA, there’s no point — you don’t need to avoid taxes on your procrastinated spending, you’re probably not being taxed much to begin with. This is one of the reasons I’ve opted to treat my TFSA as long-term, retirement savings rather than just general savings.
If you’re earning $50,000 or less per year, the annual TFSA contribution room essentially represents 14%+ of your net pay. I’m a big advocate of saving at least 30% to 35% of your income, but that’s hard to do if you have a lot financial obligations. Depending on how high your expenses are or if you have debt, maxing out your TFSA may be enough of a challenge itself. If you are lucky enough to have money left over for more savings after maxing out your TFSA, you can put it in an RRSP and claim the deduction in future years. Alternatively, you can save in unregistered accounts, particularly for future purchases that don’t contribute to your long-term wealth building, like a wedding or a car.
If your income is between $50,000 and $70,000 per year, contribute both to a TFSA and RRSP.
With an annual income greater than $50,000, you can reduce your taxes by contributing to an RRSP, but the TFSA is still a great wealth-building tool. For this reason you should contribute to both of these accounts, with the intention of maxing out your TFSA and secondly building up your RRSP.
I started contributing to an RRSP when I was 25. My income was ~$50,000 and I found it was relatively painless to tackle both the RRSP and TFSA… mostly because my RSP contributions were mandatory through my employer (you can take a peek at my old paycheque here!). I continued to make small contributions to my personal RRSP throughout the 2 years I worked at my old job, but my primary focus was maxing out my TFSA (and paying off my $21,000 student debt, of course!).
How much you choose to contribute to each account is ultimately up to you, but your ultimate goal should be to max out both. If you succeed in saving 1/3 of your income at a $70,000/yr salary, this will be enough to max out both your TFSA and RRSP annually, with some leftover to catch up on missed years or begin building wealth in unregistered accounts.
If your income is greater than $70,000 per year, contribute to an RRSP before you contribute to your TFSA.
If your income is north of $70,000, savings should go towards your RRSP before your TFSA, but you definitely earn enough to tackle both. By contributing to your RRSP, you’ll reduce your income taxes and you can use that money you save to put into your TFSA. If you’re living well within your means, you probably even have money leftover after both the TFSA and RRSP to invest in unregistered accounts.
You can use the “TFSA vs. RRSP” tool on WealthBar.com to determine how to best split your savings between a TFSA and RRSP if your income is >$70,000.
For ease of bookkeeping, you might wish to max out your TFSA first in the first 1-2 months of the new year, and then spend the rest of the year focusing on your RRSP. Or you can allocate a monthly contribution to both accounts, and an unregistered account. Regardless, you’ll be able to do both. If your income is over $135,000 your RRSP and TFSA contributions will be less than 1/4 of your net income, leaving you a lot of money leftover to invest in unregistered accounts.
Individual circumstances can determine which strategy is best for you.
As a student that funded my own education, I’ve enjoyed a tuition credit for my taxes almost every year. By the time I finished off all the the tuition credits I had amassed for my undergraduate degree, I went back to school for my MBA, which earned me a whole bunch more. Tax credits like these can change which account works best for you: if you have a lot of income tax advantages, you might not need more from contributions to an RRSP. Likewise, things like running your own business or having an unpredictable income can influence where you put your savings, since the TFSA is more liquid than the RRSP.
Your ultimate goal should be to max out both the TFSA and RRSP, and you should focus on ways to increase your income in order to do so.
Right now I’m contributing over $1,000/mo to each of my RRSP and TFSA. This will let me max out my TFSA this year, at which point I’ll redirect the funds to maxing out my RRSP. Because my income is >$70,000, the RRSP is a huge focus for me, but since I can max out my TFSA in less than 1 year I want to get that done as soon as possible. I will likely claim some of the income tax deductions for my RRSP contributions, but I think I’ll carry most over to future years, as I’m expecting my income to continue to increase.
Do you contribute to an RRSP or TFSA? What is your strategy for maxing out either or both?