RRSPs and TFSAs – figuring out where to contribute (February 2021)
For most taxpayers, the first few months of the year are a seemingly unending series of bills and payment deadlines. During January and February, many Canadians are still trying to pay off the bills from holiday spending. The first income tax instalment payment of 2021 is due on March 15 and the need to pay any tax balance for the 2020 tax year comes just 6 weeks after that, on April 30. Added to all of that, the deadline for making an RRSP contribution for 2020 falls on March 1, 2021.
The best advice on how to avoid a cash flow crunch, at least as it relates to RRSP deadlines, is to make RRSP contributions on a regular basis throughout the year. That is, however, more of a goal than a reality for the majority of Canadians, especially given the job and income losses experienced by so many during 2020 and into 2021.
All that notwithstanding, Canadians who wish to deduct an RRSP contribution on their income tax return for 2020 must make that contribution on or before March 1, 2021. The maximum allowable current-year contribution which can be made by any individual taxpayer for 2020 is 18% of that taxpayer’s earned income for the 2019 year, to a statutory maximum of $27,230.
Those are the basic rules governing RRSP contributions for the 2020 tax year. For most Canadians, however, those rules are just the starting point of the calculation, as millions of Canadian taxpayers have what is termed “additional contribution room” carried forward from previous taxation years. That additional contribution room arises because the taxpayer either did not make an RRSP contribution in each previous year, or made one which was less than his or her maximum allowable contribution for the year. For many taxpayers that additional contribution room can amount to tens of thousands of dollars, and the taxpayer is entitled to use as much or as little of that additional contribution room as he or she wishes for the current tax year.
It’s apparent from the foregoing that determining one’s maximum allowable contribution for 2020 will take a bit of research. The first step in determining one’s total (current year and carryforward) contribution room for 2020 is to consult the last Notice of Assessment which was received from the Canada Revenue Agency (CRA). Every taxpayer who filed a return for the 2019 taxation year will have received a Notice of Assessment from the CRA, and the amount of that taxpayer’s allowable RRSP contribution room for 2020 will be summarized on page 3 of that notice. Taxpayers who have discarded (or can’t find) their Notice of Assessment can obtain the same information by calling the CRA’s Telephone Information Phone Service (TIPS) line at 1-800-267-6999. An automated service at that line will provide the required information, once the taxpayer has provided his or her social insurance number, month and year of birth, and the amount of income from his or her 2019 tax return. Those who don’t wish to use an automated service can call the CRA’s Individual Income Tax Enquiries Line at 1-800-959-8281 and speak to a client services agent, who will also request such identifying information before providing any taxpayer-specific data. Finally, for those who have registered for the CRA’s My Account service, the needed information will be available online.
One question that doesn’t often get asked by taxpayers is whether it actually makes sense to make an RRSP contribution. The wisdom of making annual contributions to one’s RRSP has become an almost unquestioned tenet of tax and retirement planning, but there are situations in which other savings vehicles — particularly the Tax-Free Savings Account (TFSA) — may be the better short-term or long-term option or even, in some cases, the only one available.
When it comes to making a contribution to one’s TFSA, the good news is the timelines and deadlines are much more flexible than those which govern RRSP contributions. A contribution to one’s TFSA can be made at any time of the year, and contributions not made during the current year can be carried forward and made in any subsequent year.
On the other hand, determining one’s total TFSA contribution room is significantly more complex than figuring out one’s allowable RRSP contribution amount, for two reasons. First, the maximum TFSA amount has changed several times (increasing and decreasing) since the program was introduced in 2009. Second, and more important, individuals who withdraw funds from a TFSA can re-contribute those funds, but not until the year following the one in which the withdrawal is made. Especially where a taxpayer has several TFSA accounts, and/or a history of making contributions, withdrawals, and re-contributions, it can be difficult to determine just where that taxpayer stands with respect to his or her current maximum allowable TFSA contribution amount.
In this case, there’s no help to be had from a Notice of Assessment, as the CRA does not provide TFSA contribution information on that form. Information on one’s current year TFSA contribution limit can, however, be obtained from the CRA website, from the TIPS line at 1-800-267-6999 or its Individual Income Tax Enquiries line at 1-800-959-8281, as outlined above. It should be noted, however, that information on one’s current (i.e. 2021) TFSA contribution limit won’t be available through the TIPS line until mid-February 2021.
Determining which savings vehicle is the better option for a particular taxpayer will depend, for the most part, on the taxpayer’s current and future tax situation, the purpose for which the funds are being saved, and the taxpayer’s particular sources of retirement income.
Taxpayers who are saving toward a shorter-term goal, like (hopefully!) next year’s vacation should direct those savings into a TFSA. While choosing to save through an RRSP will provide a tax deduction on that year’s return and, possibly, a tax refund, tax will still have to be paid when the funds are withdrawn from the RRSP in a year or two. And, more significantly from a long-term point of view, repeatedly using an RRSP as a short-term savings vehicle will eventually erode one’s ability to save for retirement, as RRSP contributions which are withdrawn cannot be replaced. While the amounts involved may seem small, the loss of contribution room and the compounding of invested amounts over 25 or 30 years or more can make a significant dent in one’s ability to save for retirement.
Taxpayers who are expecting their income to rise significantly within a few years – for example students in post-secondary or professional education or training programs – can save some tax by contributing to a TFSA while they are in school and their income (and therefore their tax rate) is low, allowing the funds to compound on a tax-free basis, and then withdrawing the funds tax-free once they’re working, when their tax rate will be higher. At that time, the withdrawn funds can be used to make an RRSP contribution, which will be deducted from income which would be taxed at that higher tax rate. And, in a need for funds should arise in the meantime, a tax-free TFSA withdrawal can always be made.
Canadians aged 71 and older will find the RRSP vs. TFSA question irrelevant, as the last date on which taxpayers can make RRSP contributions is December 31 of the year in which they turn 71. Many of those taxpayers will, however, have converted their RRSP savings to a registered retirement income fund (RRIF) and anyone who has done so is required to withdraw (and be taxed on) a specified percentage of those RRIF funds every year. Particularly where required RRIF withdrawals exceed the RRIF holder’s current cash flow needs, that “excess” income can be contributed to a TFSA. Although the RRIF withdrawals made must still be included in income for the year and taxed as such, transferring the funds to a TFSA will allow them to continue compounding free of tax and no additional tax will be payable when and if the funds are withdrawn. And, unlike RRIF or RRSP withdrawals, monies withdrawn in the future from a TFSA will not affect the planholder’s eligibility for Old Age Security benefits or for the federal age credit.
RRSPs and TFSAs are the most significant tax-free or tax-deferred savings vehicles available to Canadian taxpayers, and both have a place in most financial and retirement plans. To help taxpayers make informed choices about their savings options, the CRA provides a number of dedicated webpages about both RRSPs and TFSAs, and those can be found on the CRA website at http://www.cra-arc.gc.ca/tx/ndvdls/tpcs/rrsp-reer/menu-eng.html and http://www.cra-arc.gc.ca/tx/ndvdls/tpcs/tfsa-celi/menu-eng.html.