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RRSP vs TFSA – Do Higher Interest Rates change things?

Interest Rates - TFSA vs. RRSP

If you ask most Financial Advisors or Accountants whether putting funds into TFSAs or RRSPs make more sense, there is an almost scarily uniform answer that TFSAs are better. It is scary because – typically – if you ask why you are met with a blank stare and offered some sort of a canned answer like “tax-free is obviously better”. It’s also scary as Advisors and Accountants very rarely agree on much of anything. The correct answer is, of course, it depends. It depends on a lot of circumstances: your other Pension income; your spouse; your saving and spending habits; your age; and pretty much anything other than your shoe size.

But, what about the expected interest rate? Have the recent increases changed the RRSP vs TFSA debate?

Rising Interest Rates - TFSA versus RRSP

Today is the RRSP contribution deadline, so we thought appropriate to spend a moment on this topic.

The answer on RRSP vs TFSA is an individual analysis which must weigh many factors. To truly make an informed decision there are a lot of variables – investment type (Stocks, Bonds, GICs), life expectancy, other pension income, spouse’s income, and retirement age, etc. We cannot provide individual advice without knowing the factors. On a macro basis how have interest rates changed things in the TFSA vs. RRSP debate?

TFSA and RRSP basics

Lets get back to the basics – TFSAs grow tax free, RRSPs grow tax deferred. The principal in a TFSA grows tax-free, but the principal is after tax money. The principal in an RRSP is pre-tax and grows tax-free until you withdraw it, when it is taxed. With RRSPs, your initial principal is therefore 20-50% higher (being pre-tax) than with a TFSA.

Tax Deferral and Interest Rates

Here lies the rub, with higher interest rates, the value of that tax-deferral increases. The 20-50% of deferred taxes grows at a higher interest rate, and it is therefore more beneficial over the term of the RRSP, both in the accumulation phase, and in the withdrawal phase.

TFSAs were introduced largely when interest rates were low, where the value of a tax-deferral wasn’t as large. However, now with interest rates increasing, the value of a tax deferral has increased.

Perhaps it is time to re-evaluate, to ensure you are making the best decision.

Let us develop a tax plan for you, or read more here.


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