TFSA or RRSP: Where Should your Down Payment Fund and Retirement Savings Go?

Many young professionals are simultaneously saving for two major goals: buying a home and starting to save for their future (a.k.a. retirement or financial independence). In my recent blog post, I outlined the various accounts that can be used for a variety of savings goals. Two tax-sheltered accounts are available to young professionals for both retirement savings and a house down payment – the Tax Free Savings Account (TFSA) and the Registered Retirement Savings Plan (RRSP). This begs the question, which one should be used for each goal to produce higher long-term wealth? In this blog, I assess how the choice of savings vehicle impacts long term wealth for both individuals and couples with varying income.

The high level math around whether the TFSA or the RRSP is better for retirement savings concludes: if your taxable income is higher while you are working than it is when you retire, the RRSP should be used for long-term retirement savings. This is often the case for a number of reasons: retirees are able to split their pension income with their spouses, often resulting in lower income taxes; there are additional tax credits for seniors like the age credit and the pension credit.

The Numbers

I looked at a variety of scenarios, accounting for taxes and investment returns (including the volatility associated with investment returns) to help determine the more advantageous savings vehicle.

ASSUMPTIONS
Investment Portfolio	60% Equity / 40% Fixed Income
Investment Return	5.15%
Current Age	25
Retirement Age	65
Life Expectancy	90
Retirement Savings	10% of Gross Income (now until age 65)
Down Payment Savings	10% of Gross Income (5 years) (Down payment = ½ Income)
Income Growth	Inflation at 2%

The TFSA is flexible and can be used for any savings goal. The RRSP, while mainly a retirement savings tool, can also be used to fund a first home purchase, up to $25,000. There are requirements to pay back the $25,000 within a specific time frame, which I have incorporated into the simulations below. In order to keep things comparable, I paid back the down-payment amount over the 15 year period, irrespective of which account(s) it came from.

Within the following scenarios, savings is more than 20% because I assumed that 10% of gross income would be saved after-tax for each goal. For example, if a single earner made $50,000 per year, I assumed that they could save $5,000 after-tax towards their retirement, and $5,000 after-tax towards a down payment. However, if an individual uses the RRSP for their savings, they could actually save more ($7,130), due to the tax deduction, and still spend the same amount of money on regular consumption. In this case, savings would total 24% of their gross income and closer to 30% of after-tax income. If the same amount is saved in the TFSA as the RRSP, and any tax refund is spent, the TFSA is a better savings option. The reason: the tax benefit of contributing to the RRSP wouldn’t achieve higher savings but taxes would have to be paid on the withdrawal, whereas the same amount in the TFSA would not be taxed upon withdrawal.

In order to compare whether the TFSA or RRSP is a better choice for long-term wealth while considering the above two goals, I assessed which scenario provided a higher replacement ratio in retirement. If the above $50,000 earner was spending $28,578 on regular consumption (i.e. income after tax, CPP/EI deductions, and savings), how well could they achieve that same level of spending throughout retirement? If their maximum spending in retirement was estimated to be $30,000, the replacement ratio would be 105% (the individual could spend more in retirement than they are currently spending). If retirement consumption was $25,000, the replacement ratio would be 87%, and the individual would have to cut their spending in retirement.

The results based on the simulations are as follows:

		CONSUMPTION REPLACEMENT RATIO
INCOME	MARITAL STATUS	TFSA FOR HOUSE RRSP FOR RETIREMENT	RRSP FOR HOUSE TFSA FOR RETIREMENT
$50,000	Individual	111%	109%
$50,000 / $0	Couple	131%	121%
$25,000 / $25,000	Couple	119%	117%
$100,000	Individual	94%	90%^1,2
$100,000 / $0	Couple	109%	96%
$50,000 / $50,000	Couple	111%	107%
$150,000	Individual	92%	86%^1,2
$100,000 / $50,000	Couple	101%	96%^1,2
$75,000 / $75,000	Couple	97%	94%^1,2

Source: PWL Capital Inc., NaviPlan Calculations
¹ For house down payments that exceed the $25,000 Home Buyers Plan limit (e.g. a $75,000 down payment for the $150,000 earners), the remaining down payment amount is taken from the TFSA.
² For higher income earners, it is not possible to stay within the contribution limits in the TFSA to fully save for retirement. The TFSA was used as the main savings tool until it was maximized, and the remaining savings went into the RRSP in the amount that kept consumption equal.

As you can see from the above chart, using the TFSA for a house down payment and the RRSP to save for long-term retirement is a better option irrespective of total income or marital status. The larger tax benefit results in more RRSP savings long-term with the required taxes on withdrawals being less than the initial tax benefit. This is also good news for those who might be tempted to withdraw their retirement savings for items other than retirement if most wealth was held in the TFSA.

Things to Note

These projections use current tax laws and social security estimates. The results may change if these laws and programs change.

For many young professionals, they expect to increase their earnings by more than inflation over time as they get more experience. For this reason, many look to maximize their TFSA’s first, and then use their accumulated RRSP contribution room when their incomes are higher, providing a larger tax refund. This can be a good option if you expect to maximize your tax-sheltered accounts over time.

While the RRSP is shown to provide greater long-term wealth when used for retirement in all the above scenarios, these results may change depending on individual circumstances. If you are interested in finding out which option is best for you, get in touch and we can run the numbers for your specific situation.