TFSAs and RRSPs: Allocating your savings

You can use both a TFSA account and an RRSP account with the Advantages Retirement Plan™

Learning Objectives

  • Inform your decision to allocate your Advantages Retirement PlanTM savings between a TFSA account and/or an RRSP account
  • Learn why many physicians may want to allocate retirement savings into both TFSAs and RRSPs

Key Insights

  • The Advantages Retirement PlanTM includes both an RRSP account and a TFSA account
  • Most physicians will need both TFSAs and RRSPs: While an early-career physician might begin saving with only one of these two account types, most physicians may want to consider maximizing their contributions to both types of accounts in order to successfully meet long-term retirement savings goals
  • Digging into the differences: Both RRSPs and TFSAs provide tax-advantaged savings opportunities, but there are important differences between them, such as how they are taxed and how contribution limits are set
  • RRSP room requires taking income as salary: To generate RRSP room, incorporated physicians will need to ensure that they take at least some of their income as salary, rather than as dividends, since RRSP room is dependent on “earned income,” which includes salary but not dividends
  • Finding a balance: If you’re not sure how to allocate your savings between your RRSP and TFSA accounts, the Advantages Retirement PlanTM has a default allocation, based on what may be tax-efficient for the majority of physicians. The Advantages Retirement PlanTM’s default option is to allocate the first $500 per month of savings to your TFSA account and any additional savings to your RRSP account
  • Know your limits: As you’re accumulating retirement savings in your TFSA and RRSP, you’ll need to ensure you don’t exceed the contribution limits for these accounts — your annual Notice of Assessment and/or an online account with the Canada Revenue Agency can help you keep track of what your limits are

TFSA vs. RRSP? A physician-specific lens

If you’re thinking about saving for retirement, you’re probably familiar with these two tax-advantaged savings accounts: the Registered Retirement Savings Plan (RRSP), and the Tax-free Savings Account (TFSA). The Advantages Retirement PlanTM includes both account types. What might physicians want to know about using RRSPs and TFSAs for retirement savings?

Both accounts were established to help Canadians save, and both have limits to how much you can contribute each year. But there are important differences between the two.

When you add funds to save through a TFSA account, you are making contributions from income you’ve already paid tax on. Since you’ve already paid tax on any funds that you put into your TFSA, you cannot deduct TFSA contributions from current income. Your contributions grow tax-free while they’re in the TFSA account, and you aren’t taxed on any withdrawals.

In contrast, when you add funds to save through an RRSP account, you are making contributions from pre-tax income (meaning the amount of your contribution is deducted from your current income before it is taxed). Your RRSP contributions grow tax-free while they’re in the plan, but are taxed on withdrawals for retirement income.

There are some additional RRSP-related considerations that may be more applicable to physicians than to the typical Canadian. For example, incorporated physicians have the option to take compensation as dividends, salary, or a mix of both. When compensation is taken in the form of dividends, however, no RRSP room is created, as dividends do not qualify as “earned income” for the purposes of creating RRSP contribution room.

As a result, to take full advantage of the tax deferral available through RRSPs, incorporated physicians need to ensure that they receive compensation in the form of a salary, or a mix of both salary and dividends. [1]

TFSA contribution room, in contrast, is not dependent on how compensation (i.e. salary and/or dividends) is categorized and received.

“If you are an incorporated physician using an RRSP to save for retirement, you will need to ensure that you receive compensation in the form of a salary, or a mix of both salary and dividends.”    

A second consideration specific to physicians is related to a physician’s compensation trajectory over a lifetime. A physician’s earnings usually starts out late and relatively low (compared to, for example, a Canadian earner with a post-graduate degree), but then climb rapidly and steeply as a physician establishes a practice. This can mean that physicians may benefit from starting to save in a TFSA account, followed by saving additional funds in an RRSP as earnings (and thus the tax rate) climb over time, so long as the earnings are in the form of salary.

Another factor to consider is the ultimate use of funds saved in either a TFSA or RRSP. If you withdraw from your TFSA, your TFSA contribution room is restored (with exceptions) at the beginning of the following calendar year.[2] If you withdraw from your RRSP, your contribution room will not be restored. TFSAs may be helpful in the case of emergency situations when you might need some flexibility for temporary changes in financial needs.

As total compensation increases over the course of your lifetime, the fraction of earnings that can be contributed to tax-advantaged savings accounts — both RRSPs and TFSAs — diminishes. As a result, many physicians may opt to fully fund both accounts over time, to ensure that they maximize the tax benefits associated with saving in both registered savings accounts.

RRSPs vs. TFSAs – What options are available for my retirement savings?

With the Advantages Retirement PlanTM, you can choose how you want to allocate your savings between your TFSA and RRSP accounts. The Advantages Retirement PlanTM offers educational materials to help you make your allocation strategy.

In the Advantages Retirement PlanTM, the default option is for members to allocate their first $500 per month of contributions to a TFSA, and any amount above that to an RRSP. This default is based on a lifecycle approach, which prioritizes saving in a TFSA earlier on, when earnings may be lower, and then later on prioritizes adding savings in an RRSP as earnings — and thus tax deductions from RRSP contributions — increase over time.

If obtaining a tax deduction on current earnings is your priority, you can direct your savings to first go into an RRSP, and contributing to a TFSA only once you have reached the maximum of your RRSP contribution room. If you contribute into both RRSP and TFSA, you would be able to get the corresponding tax benefits from each.

Know Your Limits: Managing RRSP and TFSA contribution room over time

The amounts that you can contribute to a TFSA and an RRSP are set by Income Tax Act rules. This means that you need to ensure that you don’t exceed your available “contribution room” in all your TFSA and RRSP accounts. Overcontributions are subject to penalties. As a member of the Advantages Retirement PlanTM, it is your responsibility to make sure you don’t exceed your contribution limits for each account type.

Your contribution limit is unique to you and takes into account new contribution room that you generated each year, as well as any past unused contribution room amounts from previous years. One way to track and manage your contribution room over time is through the My Account service provided by the Canada Revenue Agency, which is “a secure online portal that lets you view your personal income tax and benefit information and manage your tax affairs online.”[3]

RRSPs and TFSAs: A comparison

RRSP TFSA
History • Introduced in 1957 to provide a tax-deferred retirement savings account for Canadians without employer-sponsored pension plans • Introduced in the 2008 federal budget as a “flexible savings vehicle” for Canadians
• Came into effect on January 1, 2009
Tax implications
Contributions • Deducted from your taxable income • Made from after-tax income (no tax deduction for contributions)
Investment earnings (while your savings are in the plan) • Never taxed • Never taxed
Withdrawals • Taxed as income • Never taxed
Maximum yearly contribution • Based on a percentage of your “earned income” for the year, to a maximum set by Income Tax Act rules
• In 2021, the maximum you can contribute to an RRSP is 18% of your earned income to a limit of $27,830 (minus pension accruals if you have a pension plan)
• You can make additional contributions if you have not maximized contributions in previous years         
• Not dependent on level of income
• Available to all Canadians age 18 and over
• 2020 contribution limit is $6,000
• You can make additional contributions if you have not maximized contributions in previous years   
Where to find your contribution room • The My Account service provided by the Canada Revenue Agency (CRA)
• Your yearly Notice of Assessment, which you receive after your tax return has been reviewed and assessed by the CRA
• The My Account service provided by the Canada Revenue Agency
• Your latest tax return

 

The Government of Canada provides additional information about RRSPs and TFSAs.

References

[1] Several recent analyses have modelled the benefits of TFSAs and RRSPs for incorporated professionals. While the results will depend on the assumptions used, the results of recent analyses show that using TFSAs and RRSPs to save for retirement can provide greater benefit for the incorporated physician than a “dividends-only” compensation strategy. See in particular Jamie Golombek, Managing Director, Tax & Estate Planning, CIBC Wealth Advisory Services, “TFSAs for Business Owners . . . A Smart Choice” (October 2015) and Benjamin Felix, Associate Portfolio Manager, PWL Capital Ltd., “A Taxing Decision: Determining the worth of registered accounts for owners of small business corporations” (July 2017).
[2] https://www.canada.ca/en/revenue-agency/services/tax/individuals/topics/tax-free-savings-account/making-replacing-withdrawals-a-tfsa.html
[3] https://www.canada.ca/en/revenue-agency/services/e-services/e-services-individuals/account-individuals.html