Where should working retirees put extra income: A TFSA or an RRSP?
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I will be receiving CPP and OAS as of June 2024. I intend on working one more year until I reach 66. My question is: Should I put all my CPP money into an RRSP to shelter it from tax? Or should I pay the tax on it and invest in a tax-free savings account?
–Gary
Where to put retirement income: RRSP or TFSA
Gary, believe it or not, it doesn’t matter if you contribute to a registered retirement savings plan (RRSP) or a tax-free savings account (TFSA). You get the same (after-tax) results. Well, almost.
But, before we go there, are you aware that you don’t have to start your Canada Pension Plan (CPP) benefits and Old Age Security (OAS) at age 65? Let’s do a quick recap on delaying CPP and OAS, and then tackle your RRSP versus TFSA question.
Should you delay CPP and OAS to after 65?
CPP benefits increase by 0.7% for every month delayed past your 65th birthday, working out to an annual increase of 8.4%. Plus, the CPP benefit is based on the average yearly maximum pension earnings (AYMPE)—the maximum salary amount on which you need to contribute to the CPP—over the last five years.
If that average grows faster than the consumer price index, the CPI, then you will have to earn more than 8.4% to match your CPP if you delay one year. This is because once you receive CPP, it’s indexed to the CPI and not to the AYMPE.
OAS benefits increase by 0.6% for every month delayed past your 65th birthday, which is 0.1% less than the CPP increase. It works out to an annual increase of 7.2%. The other notable difference between the CPP and the OAS is that your OAS will start to be clawed back if your net income is over $90,997 in 2024. There’s an OAS recovery tax of 15% on every dollar earned above $90,997.
You must apply to start your CPP, whereas OAS starts on its own and it is up to you to apply to stop the OAS within six months if you want it delayed. If your plan is to start drawing on CPP and OAS to invest, you may not want any of that tax withheld. This is so you can invest the full amount.
There’s another thing to think about with CPP and working past age 65. If you haven’t maximized your CPP it may be better to delay and use the extra working year to build more CPP credit. If you start your CPP and work past age 65, you will still be making CPP contributions, earning the less valuable post-retirement benefit unless you complete this form to stop making CPP contributions.
Okay Gary, why did I spend time reviewing CPP and OAS? Simply to say that a guaranteed 8.4% return on the CPP, which is indexed for life, is a good investment.
Are you sure you can do better? The same goes for the OAS, plus if your income is over $90,997, consider delaying OAS because you’re going to lose some to clawback.
RRSP vs. TFSA for retirees
Now to your question: Should you contribute to your RRSP or TFSA? I don’t know your circumstances, but I can show you the math. In the table below, you are going to see that there is no real difference if your marginal tax rate is the same at time of contribution and time of withdrawal.
RRSP vs. TFSA comparison on a $10,000 contribution over one year
| RRSP | TFSA | |
|---|---|---|
| Gross contribution | $10,000 | $10,000 |
| Income tax (30% tax rate) | $0 | $3,000 |
| Net contribution | $10,000 | $7,000 |
| 5% investment growth | $500 | $350 |
| Value of account | $10,500 | $7,350 |
| Tax owing | $3,150 | $0.00 |
| After tax value | $7,350 | $7,350 |
The math for retires investing in an RRSP and TFSA
The above table shows that all things being equal a dollar invested into a RRSP or TFSA yields the same results. This is why it’s argued that an RRSP provides tax-free growth after all if, dollar for dollar, it gives the same after-tax value as a TFSA.
How could it not?
You may have questions about the table. For example, if you invest $10,000 and end up with $7,350 after one year, how is that a good investment? The $10,000 number is a before-tax figure. Remember, if you’re given $10,000 at the beginning of the year, and have a marginal tax rate of 30%, then you would be left with $7,000. Investing in a RRSP or TFSA leaves you with $7,350 after tax, so you have a gain.
The other thing to remember is that RRSP contributions are made with pre-taxed money and TFSA contributions are made with after-tax money. This is why you see the $3,000 income tax entry under the TFSA column, to make it a fair comparison.
Where should Canadian retirees put their money
Now to your question Gary, should you contribute to your RRSP or TFSA? You see there’s no difference between investing inside an RRSP or a TFSA if your marginal tax rate is the same at time of contribution and withdrawal. If your marginal tax rate is higher at time of withdrawal, then the TFSA has the advantage. Conversely, if your tax rate is lower at time of withdrawal the advantage goes to the RRSP.
Also, consider that RRSPs and TFSAs are both available tax shelters to maximize when sensible and if possible. Canadians are to only contribute to their RRSPs until they turn 71, whereas TFSA contributions can be made right up until death. If there’s a chance you receive a lump sum of money from an inheritance, home sale, and so on, you may want to save your TFSA contribution room and use your RRSP now, while you can.
There are some other finer details to think about. Does the RRSP tax deduction help with your age credit? Will future RRSP withdrawals result in OAS or Guaranteed Income Supplement clawback?
Gary, I have written a lot here for you to think about, and hopefully you find something useful to your situation. But ultimately, we’re only talking here about one year. In the long run what you do is not going to make much difference either way. This is a case when I would suggest you do what you’re most comfortable with and feel good about your decision.
Read more about TFSAs and RRSPs:
- How does a TFSA work?
- What investments can I put in my TFSA?
- How much should I have in my RRSP?
- Should you hold on to unused RRSP contributions?
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