It is undeniable that Tax-Free Savings Accounts (TFSAs) have unique advantages but I’m somewhat surprised by some recent reports that suggest that a lot of Canadians would be better off contributing to a TFSA instead of a RRSP. These arguments forget to take into account the unique advantages offered by RRSPs.
Defer income taxes
RRSPs allow taxpayers to defer their income tax obligations to a future year. Taxpayers with wildly fluctuating incomes can smooth out their income tax obligations by contributing to a RRSP in fat years and withdrawing from it in lean years.
When one spouse earns a much higher income than her partner, she can take advantage of income splitting opportunities offered by RRSP accounts. She can contribute to a spousal RRSP and get her income taxed at the hands of the lower income spouse. She can take advantage of income splitting available to seniors who withdraw from a RRSP or RRIF. The tax benefits of income splitting can be substantial.
Increase in income-tested benefits
It is true that withdrawals from a RRSP or RRIF may result in a reduction of income-tested benefits. But the flip side is often neglected. Contributions to a RRSP reduce one’s taxable income and increases income-tested benefits such as the Canada Child Tax Benefit.
Here’s an example. An Ontario couple with two children, earning $50,000 each will receive an annual CCTB of $335. If the couple contribute $9,000 each to their RRSPs their CCTB payments will increase to $1,055 per year.
Shelter foreign investments from tax
Investors who hold globally diversified portfolios should hold their US equities and US-listed ETFs in their RRSPs. Dividends from foreign equities in taxable accounts are taxed at marginal rates. US stocks and ETFs held in TFSAs are dinged a 15% withholding tax. When held in RRSP accounts, these assets are sheltered from tax until withdrawal.
Canadians in the lowest tax brackets will almost certainly better off saving for retirement inside a TFSA. And those in the highest tax brackets are almost certainly better off contributing to RRSPs at the expense of TFSAs. It is impossible to say with any degree of certainly whether one account is better than the other for Canadians in middle tax brackets because of uncertaintly over future tax rates. The superiority of TFSAs is certainly not the slam dunk it is made out to be in some quarters.