TFSA or RRSP – How should business owners approach saving for retirement?

If you are self-employed or own a business that you work full-time, saving for retirement can be challenging. Alongside focusing on business growth, you should consider how you will fund your future retirement. In Canada, the TFSA and RRSP provide opportunities to save for retirement in a tax-advantaged way. Ideally, we should maximize contributions to both TFSA and RRSP. However, most of us need more resources and must choose how to save for the future. Both accounts provide tax benefits to save money and reach your financial goals. For business owners, there are additional complexities to consider. We’ll review the differences between the RRSP and TFSA and considerations of particular interest to business owners and entrepreneurs.

Differences between RRSP and TFSA

Both the RRSP and TFSA offer tax incentives when saving for the future. Before we dive into which account is a better vehicle for you as a business owner, we’ll cover the basics of these accounts.

What is the RRSP?

An RRSP or Registered Retirement Savings Plan is a tax-deferred account. The big reason for anyone to contribute to an RRSP is to reduce their current taxable income. When you contribute to your RRSP, you can defer income taxes to the future. You will be taxed on this when you withdraw money from your RRSP after you retire. The contribution room in an RRSP is based on your income for the year. Generally, you can contribute up to 18% of your annual income (up to the prescribed limit). For example, earning $60,000 this year can contribute $10,800 to your RRSP. The amount you contribute is then a potential tax deduction for you. The RRSP is a great way to save for retirement. If you withdraw from the account early, you must pay some penalties. Some exemptions include taking out money from your RRSP to purchase a home (Home Buyers Plan) or going back to school (Lifelong Learning Plan). You do not pay the fine if you pay it back to your RRSP within the time limit.

What is a TFSA?

The TFSA, or a Tax-Free Savings Account, is a tax-sheltered account. The amount you contribute to your TFSA is based on after-tax income. However, any gains or income in that account is tax-free. The amount in the account is not subject to any investment income tax or capital gains tax, allowing you to grow your money without paying taxes. If you are a resident of Canada over 18, you can open a TFSA and contribute to it. Your income does not affect the contribution room in your TFSA. You contribute to your TFSA with after-tax income; you have already paid taxes before investing or saving in your TFSA. Any future growth or investment income is tax-free, making the TFSA a great way to invest your money.

RRSP or TFSA – Considerations for business owners

As a business owner and manager, you have different options available to you in terms of how you save for the future. You can leave excess funds in your company and grow it in the corporation, or take it as a salary or dividend and invest it using your personal accounts. TFSAs and RRSPs account for individuals, not corporations. If you choose to invest funds using these tax-advantaged accounts, what is the better option, a TFSA or RRSP? Let’s look at the various considerations from the eyes of a business owner.

How much do you want to contribute?

One big difference between the two accounts is how much you can contribute. The RRSP contribution limit is calculated from your income. If you are a business owner who does not take a salary, you will not be building your contribution room in the RRSP. On the other hand, the contribution room makes for all residents in Canada over the age of 18, regardless of their employment income. While the TFSA has broader eligibility, the annual contribution limit for most people will be lower than the RRSP. A business owner who takes compensation in the form of only dividends will not build any room in their RRSP but will continue to increase contribution room in their TFSA.

When and why do you need the funds?

Another significant difference between the TFSA and RRSP is the penalties for withdrawals. The RRSP is a vehicle to save for retirement. As a result, any withdrawals made before retirement are subject to income tax and an additional withdrawal tax. There are two exceptions. You can withdraw from your RRSP for the following reasons:

• Buy a home – under the Home Buyer’s Plan (HBP)
• Full-time education or training program – Lifelong Learning Plan (LLP)

There are no penalties when you withdraw from your RRSP to buy a home or return to school. But you must repay the amount into your RRSP within five years if you buy a home or ten years if used for education. The TFSA has no penalties; you can withdraw your funds without penalty. This includes your contributions, as well as any investment income earned. The only caveat is that your contribution room is adjusted again only in the following year. The TFSA offers more flexibility to withdraw cash when you need it. New entrepreneurs or business owners with seasonal or volatile cash flows may prioritize their TFSA to meet personal expenses and cash flow needs. 

Current vs. Future Tax Bracket

The idea behind the RRSP is that it is a way to defer taxes in the future when you retire. The fundamental question for anyone debating whether to contribute to an RRSP or TFSA is to compare your current tax bracket to your future tax bracket. Many people may be in a higher tax bracket during their peak earning years and in a lower retirement tax bracket. For such situations, an RRSP is an ideal way to save money. For business owners, this may prove not easy to predict. If you’ve just started your business and expect to earn a higher income in future years, consider prioritizing your TFSA over the RRSP. The tax deferral in the RRSP may be worth more when you are in a higher tax bracket. However, a seasoned business owner with a mature business may already be in a high tax bracket and should maximize tax deductions using the contribution room in the RRSP.

Do you receive any government benefits?

Government benefits often use your income to calculate your eligibility and how much you receive in benefits. You may be eligible for various government benefits – now or in the future, such as:

• Canada Child Benefit (CCB),
• Ontario Child Benefit (OCB),
• Guaranteed Income Supplement (GIS),
• GST/HST Credit

TFSA contributions usually do not affect your government benefits because they are not typically used to calculate your eligibility. Your RRSP contribution, however, can affect your government benefits. Sometimes, an RRSP contribution decreases your taxable income and might increase how much you receive. Whether you contribute to a TFSA or RRSP may be influenced by your overall personal financial situation.

Saving for Your Future

The RRSP and TFSA both offer unique tax benefits for Canadian taxpayers. The right decision depends on your current situation, such as your income level and financial goals. If you are a business owner with more volatile cash flows, the TFSA might be better suited for you due to its withdrawal flexibility. On the other hand, if you’re in your peak earning season, then an RRSP contribution could help maximize your tax savings today. Your tax and advisory team can provide solutions that meet your needs.

Contact KSSP Partners LLP in Markham for Tax and Modern Accounting Solutions.

At KSSP Partners LLP, our experienced Chartered Accountants provide modern tax and accounting solutions to meet the needs of your business and personal situation. Our knowledgeable and professional tax experts at KSSP Partners LLP can offer clients in Markham, Toronto and across Ontario innovative accounting and advisory solutions. To learn how we can help you and your business with all your tax and accounting needs, contact us online or by telephone at 289-554-5997.