RRSP-TFSA concepts & coordination

Your decision depends on many factors

Since its introduction in 2009, the TFSA has proven to be a powerful tool that opens up countless possibilities for improving our finances. However, when it comes to retirement savings, the RRSP should be the default choice for most of us.

Here are some important considerations to help you decide what’s best for you.

Tax treatment IN – Tax treatment OUT

The key difference between these plans is what happens on front and back end:

- RRSP deposits are pre-tax, income within is sheltered, and withdrawals are taxable
- TFSA deposits are after-tax, income within is sheltered, but withdrawals are not taxed

If you’re depositing to an individual RRSP, any associated refund must also go into your RRSP to keep it intact as ‘pre-tax’. For workplace group RRSPs, your employer does this for you through withholding tax.

Base comparison

If your income is taxed at the same rate when contributing to and withdrawing from the investment, your spendable cash will be the same either way.

Using $100 at a 40% tax rate and a 10% return (to allow for simple arithmetic):

However, if the withdrawal tax rate is reduced to 30%, the tax on the $110 in the RRSP will be reduced from $44 to $33, netting $77. On the other hand, if the withdrawal tax rate is 50%, the tax will be $55, netting to $55.

So, if you expect your tax rate to be lower when you will be taking withdrawals from this investment, choose RRSP. But if you expect a higher rate later on, choose TFSA.

‘Same rate’ – Marginal or average?

To assist in comparing rates, keep in mind we have a progressive tax system. That means higher income is taxed at a higher rate. An RRSP contribution gives you a tax deduction at your top marginal tax rate.

On withdrawal in your later years, the appropriate comparison is average rate, which is total tax divided by income. As average rate is mathematically lower than marginal rate, RRSP is usually the default choice.

What’s your own expected average rate?

In truth, your RRSP (in the form of a RRIF or annuity draw) will not be your only retirement income. You will have Canada Pension Plan and Old Age Security, and may have a pension, all together forming your foundation income. Thus, the average rate on your RRIF/annuity will be higher than your overall average.

And if you expect your retirement income to exceed the OAS clawback level, that will raise your effective marginal tax rate – that’s when it’s time to run the numbers through a financial planning spreadsheet!

Default choice, but with flexibility

To repeat, the point here is that RRSP is the default choice, but it could be displaced. Think of it in terms of proportionally allocating savings between them, not an either-or decision. Consider these factors:

Favouring RRSP

Most people live on a lower income in retirement. Spousal pension income splitting can reduce seniors’ household tax rate. The pension credit can reduce tax on $2,000 of RRIF/annuity income.

Favouring TFSA

Savings timeframe is shorter term, not retirement. Contributor is at low bracket at saving age. There are already significant RRSP assets. A large inheritance/winfall is confidently expected

Donating RRSP/RRIF to charity

Re-directing final tax dollars to your chosen causes

As a regular supporter of your favourite charity, you’re pleased that your annual donations help keep the lights on. Ideally though, you’d also like to contribute in a way that sustains the organization over the longer-term.

One way to do this – without reducing what you need to live on – is to direct some or all of the remaining value of your RRSP or RRIF on death to your chosen charity. Not only will that make for a substantial gift in and of itself, but you’ll also be pleased to know that it comes
‘at the expense’ of some of the tax that would otherwise have been paid at your death.

Indeed, after the tax break, the donation may only cost you half of what the charity receives .

Tax imposed on registered plans at death

For many Canadians, registered retirement savings plans (RRSPs) are the primary tool used to accumulate retirement savings. Contributions are tax-deductible, with income and growth tax-sheltered while in the plan.

Commonly on retirement, an RRSP is converted into a registered retirement income fund (RRIF), which continues to enjoy tax-sheltered income and growth. Withdrawals from the plan are taxable income, but usually spread over multiple years at graduated tax bracket rates.

Still, the entire value of a RRSP/RRIF is eventually taxable.

On death, the remaining balance is treated as income that year, though that can be deferred by rolling over to a registered plan of a spouse or financially dependent child or grandchild. Otherwise, the full amount is taxed in a single year, pushing up through those graduated brackets toward the top bracket, which is within a couple percentage points of 50% or more, varying by province.

Tax relief on charitable donations

When someone donates to charity, the person may claim a credit to reduce annual taxes. The tax credit is at the lowest bracket rate on the first $200 of donations claimed in a year, being 15% federally, and ranging by province from about 5% to 20% depending on where the donor resides.

Above $200 of annual donations claimed, the tax credit jumps to a higher rate. The high rate applied against federal tax is the 4^thbracket 29% rate, or the top/5^th bracket rate of 33% if income is over that level ($246,752 in 2024). For provincial tax, Quebec and BC use the federal approach, with the other provinces applying a single high credit rate that is near or equal to their top bracket rate. This puts the combined federal-provincial credit rate near or above 50%, varying by province.

The maximum annual donation that can be claimed is equal to 75% of a taxpayer’s net income. That limit is increased to 100% in the year of death, and if the donation is larger than that final year’s net income, the excess can be used to recover tax from the preceding year’s tax bill, also based on up to 100% of net income.

Donating registered plans to charity at death

The owner of a RRSP/RRIF may designate one or more beneficiaries to receive the proceeds of a plan upon the person’s death. The plan administrator will provide a form to make that direct designation, or alternatively most provinces allow for a person’s Will to direct the proceeds of such a plan. (Note that direct designations are not available to Quebec residents, whether on the plan directly or by Will.)

A named beneficiary may be another person, or it may be an organization, such as a charity. When a charity is named, by either method, the donation is deemed to have been made immediately before the person’s death. This then qualifies the donation for that 100% threshold for both the year of death, and excess carryback to the preceding year.

Spousal flexibility

A spouse could be designated as primary beneficiary, with the charity named as contingent beneficiary. This would assure that a living survivor would continue to have full use of the couple’s savings on a first death through the usual tax-deferred rollover. Meanwhile that contingent designation would serve as a backup plan if the survivor forgets to name the charity as beneficiary after the first spouse’s death, or if there is an unfortunate common disaster.

Note that once a RRSP/RRIF has rolled to a spouse, the original owner’s instructions will have no further control over the proceeds. When carried out by beneficiary designation, the past plan ceases to exist, as does any contingent designation. When the transfer to the spouse is as successor annuitant on a RRIF, the plan and contingent designation may remain intact, but the surviving spouse has full legal control over the plan, including the right to change any designation.

Providing a legacy through the Will

Sometimes a person may be uncertain whether their estate will have enough liquidity to fund desired legacies, or even to commence administration of the estate. For example, some provinces require that the probate fee/tax is paid before the executor is granted legal authority to deal with estate property. Potentially a RRSP/RRIF could be made available for this purpose, either by foregoing the naming of a beneficiary for the plan, or by making a direct designation to the estate (on the plan or by Will).

Once the estate liquidity need has been satisfied, the net remaining funds could then be paid as a legacy to the charity. So long as the donation occurs within 36 months of the date of death, it may be claimed in the estate year when it is made or in an earlier estate year (in either case up to 75% of net income), or in the year of death or preceding year (once again, up to the 100% threshold).

Probate and estate creditors

The trade-off in allowing the RRSP/RRIF to come into the estate is that it will be subject to probate fee/tax in provinces where such applies, and estate creditor/claimants may latch onto those plan proceeds.

Comparatively, a direct beneficiary designation (other than to the estate) bypasses probate and creditors. This bypass generally applies even when the Will is the instrument used to make the designation, though this should be verified with the drafting lawyer, as probate has been levied in some provinces based on the facts in a few court cases.

Illustrating donation of RRSP/RRIF on death

To illustrate how this can work, meet Greg who lives in British Columbia. He wants to give back to the local hospital that provided such compassionate support when his spouse Jean went through palliative care. He confirms the legal name of the hospital foundation, and names it as beneficiary on his RRIF administrator’s form.

Greg understands this will reduce how much will go to their children – all financially secure adults – but expects it will also reduce the estate tax bill, making it an efficient way to donate. On his death, Greg was living in long-term care, which consumed his $25,000 income to-date that year. On death, there was a $500,000 non-registered portfolio with a $150,000 capital gain (1/2 ** being the taxable capital gain of $75,000), and a $200,000 RRIF.

RRIF – Registered retirement income fund

What happens when you are ready to draw down your RRSP?

A registered retirement savings plan (RRSP) allows you to deposit and accumulate tax-sheltered savings. Once you are ready to use those funds for your retirement, there are three options available – individually or in combination – for you to ‘mature’ your RRSP:

- Cash-in your RRSP — The entire cashed-in amount will be taxable that year, which could push you into higher tax brackets, so this is not usually desirable except to close out a small RRSP.
- Purchase an annuity — Annuities pay a guaranteed fixed amount for life or a set number of years. Payments are often made monthly, with the total annual receipts taxable each year.
- Transfer to registered retirement income fund (RRIF) — You must take a minimum amount out of a RRIF each year (except the first/transfer year), though you can take more. Amounts taken are taxable each year.

When can you start a RRIF?

You can start a RRIF at any age, not just when you are retired from working. Still, since the required withdrawals are taxable, you generally wouldn’t do so until you need the funds for living expenses – but you can’t wait forever. By the end of the year you turn 71, your RRSP must be matured by one or more of cashing-out, annuitizing or transferring to a RRIF.

Investing with continued tax sheltering

Unlike an RRSP, you cannot contribute anything more into a RRIF. To be clear though, you aren’t required to mature all your RRSPs at the same time. You may decide to keep some money in RRSP form, to be used to set up another RRIF (or annuity, or cash-out) at some time in the future, bearing in mind the age 71 outer limit.

Apart from what you take out of a RRIF, whatever remains within it will continue to grow tax-sheltered. As to investments, you are able to choose among essentially the same options available to you in your RRSP.

How are RRIF minimum annual withdrawals calculated?

A minimum must come out of a RRIF each year, based on your age as the ‘annuitant’ at the beginning of the year. Minimum withdrawal rates are on Table 1 following. The shown rate at each age is multiplied by the RRIF value at the beginning of the year to obtain the required minimum withdrawal. Once again, there is no minimum the year the RRIF is set up.

If you wish, you may use the age of your spouse/common law partner (CLP) as annuitant, which would reduce the minimum if he/she is younger. If you do this, the payments are still made to you and taxed to you, even though the rate is based your spouse/CLP’s age. When you file your annual tax return, you may be able to elect for some of that RRIF income to be split with and taxed to your spouse/CLP, as discussed further below.

Withholding tax

The RRIF administrator must withhold tax on withdrawals to remit to the Canada Revenue Agency (CRA), but only on any amounts over the minimum. See Table 2 below. Understand though that all RRIF withdrawals are taxable.

When you calculate your actual tax due on your income tax return, you receive a credit for the withheld taxes. This may lead to a tax refund if more was withheld than necessary, but if the withheld amount is insufficient then you will owe the difference.

Quarterly instalments

When you file your return, if the difference between tax payable and withheld tax is over $3,000 ($1,800 in Quebec) for the current year and either of the two preceding years, you may have to pay future taxes in quarterly instalments. This can happen for example if the RRIF is large, and the annuitant is taking only minimums without any withholding. CRA will send you an Instalment Notice if this is the case, outlining the payment due dates, amounts required and process for making payments.

Annual splitting, and transfers at death

If you are over 65, you are entitled to split up to 50% of RRIF income with a spouse/CLP, which could reduce your household tax bill if your spouse/CLP is at a lower tax bracket. You make the election on your annual tax return. Each year, you may choose to split whatever amount suits your needs, again up to the 50% maximum.

On death, the full RRIF amount is normally brought into a deceased person’s terminal year income (January 1^st to date of death). However, a tax-deferred rollover is allowed to a spouse/CLP who is named as RRIF beneficiary or who is an estate beneficiary with a financial entitlement at least as much as the value of the RRIF. It is also possible to roll to a minor child or a financially dependent disabled adult child in qualified circumstances.