Should I Use an RRSP or TFSA as a Business Owner?

If you’re self-employed or a small business owner, it might be time to start thinking about your financial future. Saving for retirement looks different when you don’t have access to an employer-funded savings plan. On top of that, you’re most likely putting as much money as you can into growing your business.

While saving for retirement might not be a top priority for you right now, there are small steps you can take to make a difference in your retirement savings. Trust us, your future self will thank you.

Investing in a registered retirement savings plan (RRSP) or tax-free savings account (TFSA) can help you achieve your retirement goals while saving on taxes. Which one is better for you? The answer is simple — both, if possible, but one might be better than the other depending on your current tax bracket and when you need the funds.

Investing in a Registered Retirement Savings Plan (RRSP)

Contributions to an RRSP are deductible against your current income, so you receive immediate tax relief and investments grow tax-free. Investing in a RRSP is a great option if you’re currently in a higher tax bracket. When you eventually go to withdraw the money in your retirement, it’s taxed at that time when you are paying lower taxes.

What is the Difference Between Your Deduction Limit and Your Contribution Limit?

Your deduction limit is the amount you’re permitted to put into your RRSP and use as a deduction on your income tax report. For the 2022 tax year, it is up to 18% of your reported 2021 income (to a maximum of $29,210, whichever is less).

Your contribution limit is equal to the current year’s deduction limit plus any unused deduction room from previous years. If you have multiple RRSPs, your deduction limit applies to all of them combined.

The RRSP must be fully withdrawn or transferred to a registered retirement income fund (RRIF) or annuity by December 31 in the year you turn 71. Otherwise, the CRA will include the entire amount of your RRSP in your taxable income that year.

Investing in a Tax-Free Savings Account (TFSA)

Investing in a TFSA is a great option if you’re in a lower income tax bracket. TFSA accounts don’t give you immediate tax relief, but your money accumulates tax-free. Withdrawals are also tax-free as contributions are made with after-tax dollars. TFSAs offer you more flexibility because you can withdraw money at any time.

You can use your TFSAs for investments like Guaranteed Investment Certificates (GICs), stocks, bonds, or mutual funds. Any investment income earned through in your account, and capital appreciation from stocks and bonds, is tax-free.

Unlike an RRSP, you don’t need earned income to accumulate the contribution room in your TFSA.

There’s technically no deadline to contribute to your TFSA. If you haven’t maxed out your TFSA, you can carry any unused contribution room into the next year – it is carried forward on January 1.

If you go over your accumulated TFSA contribution limit, this excess amount will be subject to a 1% per month penalty tax for as long as that excess amount remains in your account.

Should I Use a Registered Retirement Savings Plan or Tax-Free Savings Account?

Now, you might be wondering which one is best for you. The major points you need to consider are your current tax bracket, what you think your future tax bracket will be, and when you’ll need the funds.

If you’re in a higher tax bracket, investing in an RRSP is the better option, as it allows you to take advantage of a reduced tax rate when you withdraw the money.

On the other hand, if you’re in a lower tax bracket, a TFSA is better as it reduces your taxable income and won’t further lower your tax rate. You should consider funding a TFSA first if you’re also saving funds, such as for your business or for a down payment on a home, as you can contribute up to $6,000 per year in a tax-sheltered investment and you’re free to withdraw at any time.