RRSP or TFSA or FHSA - Something New in the Equation for 2024

February 29th is the last day for RRSP contributions for 2024. Should I focus on the RRSP, TFSA or FHSA?

We have a leap year for 2024, which means the usual March 1^st deadline has been moved to Thursday, February 29^th. Depending on your situation, contributing to the right account can get your money further. Let ‘s talk briefly about some of the savings’ options we Canadians have.

 

RRSP – Registered Retirement Savings Plan

Contributions are tax deductible against your income, reducing your overall income and thus the taxes paid. Annual limits are 18% of the previous year’s income, up to an annual maximum posted by the Canada Revenue Agency, with any unused contribution room carried forward. Any amounts withdrawn from the account are counted as taxable income, which ideally is drawn out in retirement years, where total income, and therefore marginal tax rate, is at its lowest point. These accounts must be turned into Registered Retirement Income Fund by the end of the year you turn 71, where an annual minimum amount must be taken out from the account to provide a steady flow of income.

 

TFSA – Tax-Free Savings Account

Starting in 2009, annual contributions were allowed to be made into this account to allow for tax-free growth and withdrawals with the limits being determined annually by the federal government. The major difference for the TFSA is that contributions are not eligible for any income deductions, unlike RRSPs and FHSAs. TFSAs can provide a great source of tax-free income in retirement years, but more significantly, is a great resource in estate planning to move wealth to the next generation in a tax-free manner.

 

FHSA – First Home Savings Account

This is the newest account introduced last year 2023 to Canadians to help with purchasing the ever-increasing prices of homes in Canada. To qualify for this type of account, you must have not owned a home that was your primary residence for the preceding 4 years. You are allowed an annual contribution of $8,000 per year, up to a lifetime limit of $40,000 and a time limit of 15 years or the end of the year you turn 71, at which point the account needs to be collapsed or transferred to your RRSP. Funds for the FHSA are only allowed to be withdrawn for the purpose of purchasing a qualifying home. Any investment growth is tax-free in this account.

 

So, which one is right for you?

Unequivocally, if you qualify for the FHSA, that should be your first priority, as it provides tax deductions, tax-free growth and tax-free withdrawals (on a qualifying home purchase). The RRSP and TFSA priority is subject to a little more nuance, mainly having to do with possible pensions and amount of taxable income earned.

 

In general, those who work for companies and organizations with their own pension plan can focus more on TFSA contributions, as their retirement income may already be sufficient, after factoring various government benefits such as Canadian Pension Plan payments and Old Age Security payments. Further income from RRSP/RRIF accounts may just increase the tax burden in retirement.

 

The second consideration is the level of earned income. Let’s look at 2 scenarios:

1. Person A is an Ontario resident, earning $120,000 of income. The marginal tax rate at this level is 43.41%. Making a $10,000 RRSP contribution would reduce the tax liability by $4,341.

2. Person B, also from Ontario, is earning $60,000 of income. The marginal tax rate is 29.65%. Making the exact same $10,000 RRSP contribution would reduce the tax liability by $2,965.

These scenarios illustrate that higher income levels make your RRSP contributions more effective at reducing tax. If you are at the lower tax brackets, consider making TFSA contributions instead.

 

Some special features to note with TFSAs and FHSAs: unlike RRSPs, these accounts are not recognized by the US government, and thus will be subject to withholding taxes on any US sourced income. Make note of the kinds of investments that are chosen for these accounts.

 

Want to figure out what’s right for you? We would love to help with navigating your own personal financial needs and goals. Reach out to our team anytime to get a discussion going.