TFSA vs. RRSP Part 3: Motivation of deadlines

Posted 16 Dec 2014 by Rick Irwin, CFP, CLU

The final consideration in our series has to do with certain elements of human behavior. When you consider that the RRSP has a specific deadline and an incentive for meeting that deadline (tax-savings), our pendulum swings in favour of the RRSP as the more likely vehicle to attract a higher amount of retirement savings. Of course, we should all be saving regularly throughout the year taking advantage of the pay-yourself-first principal and the benefits of dollar-cost averaging, not to mention saving as part of a well-thought retirement income plan that envisions how much will need to be put away to be able to retire comfortably when you chose. Human nature being what it is, the March 1st deadline and subsequent refund that will soon follow are big motivating factors for Canadians to open up their wallets and add to their retirement fund.

Tip: Reinvest the refund

Of note: the comparison between the after tax outcome of RRSPs and TFSAs referenced earlier is contingent on the RRSP refund being reinvested. If it is not reinvested you are still investing in RRSPs with after tax dollars only the RRSP withdrawal will be fully taxable in retirement and the TFSAs will not. A strong argument can be made if the tax refund is used to pay down high interest debt and the subsequent cash flow that would have otherwise gone to service this debt is redirected to saving but this is not always the case.

With a TFSA there is no such deadline, or tax carrot, and therefore no catalyst to make the investment. That is not to suggest that without these motivators most individuals would not put away some funds for retirement, but I do feel that for many people, without these motivators present, less saving might occur.

In a similar vein, we have been conditioned not to withdraw from our RRSPs pre-retirement due to adverse tax consequences more-so than for the long-term impact a withdrawal could have on your retirement plan. TFSAs have no such tax consequences for early withdrawal and it is more likely that without this disincentive, the TFSA-retirement-piggy-bank would get raided more often than the RRSP, leading to fewer funds saved for retirement.

In any event, which of these two investment options is better for you depends on a lot of factors: your time horizon (short-term vs. retirement), your current tax rate and expected tax rate at retirement, and your financial discipline.