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TFSA vs. RRSP: Which Should You Invest Your Next $1,000 in?

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The pandemic came along to disrupt all our plans, but the situation might begin improving, as the vaccine rollout continues. Regardless of how the situation develops with COVID-19, it is important to remember that you contribute to a Registered Retirement Savings Plan (RRSP) or a Tax-Free Savings Account (TFSA) if you can set aside some cash.

Both account types offer tax-sheltered wealth growth, but you should consider your situation and determine whether it will be better to invest in a TFSA, an RRSP, or both.

Your economic circumstances during the pandemic

Your best choice will depend on your economic situation during the COVID-19 economy. If you can stay at home to generate a stable income, it could be ideal to invest in an RRSP. If your income has suffered or your job security is unsure, it might be better to go with a TFSA to keep your cash close at hand.

TFSA vs. RRSP

Both account types have different roles that can fulfill the purpose of providing financial freedom.

An RRSP offers tax deductions upfront for making contributions. Substantial contributions to your RRSP could lead to tax refunds. However, you should know that any withdrawals from an RRSP are taxable.

The TFSA operates differently. You do not get any tax deductions for making contributions to this account, but you also do not need to pay taxes on withdrawals. If you are 18 or older, the Canada Revenue Agency (CRA) adds more contribution room to your TFSA each year. The 2021 update led to an additional $6,000 of TFSA contribution room.

Both accounts have some favourable qualities in common.

RRSPs and TFSAs offer protection from income tax on interest, dividends, and realized capital gains, as long as your funds remain invested in the account. Both accounts let you accumulate unused contribution room each year and are available for use in subsequent years.

Suppose that you accumulate enough cash during the pandemic and have unused RRSP contribution room. You may be able to make a particularly large contribution to the account, and the entire amount will be tax deductible. You can still enjoy attractive tax deductions from the get-go, and you will not be taxed for the cash until you finally withdraw it.

However, RRSPs might not be suitable for you if you might need the funds in the short term. Withdrawing any funds from your account will eat into your profits due to income taxes.

TFSA withdrawals are entirely tax-free. Plus, withdrawing from your TFSA does not mean you lose the contribution room for good. You can regain the contribution at any time in the next calendar year.

The TFSA is the newer account type of the two. It offers a comprehensive and much more flexible method to save if you need funds any time soon. If you are worried about your job or financial situation, investing in a TFSA might be the best place for your capital.

Foolish takeaway

Whether you choose to contribute to a TFSA or an RRSP, or both, it is crucial to know where to invest your cash based on your investment goals. If you are investing for retirement, the long investment horizon can give you slightly better prospects of taking risks.

Investing in stocks that offer excellent long-term returns is the ideal way to go. If you are considering higher growth, you could consider adding tech stocks like Lightspeed POS and Constellation Software to your portfolio. Bank stocks like Royal Bank of Canada and Toronto-Dominion Bank could make excellent picks for long-term, buy-and-hold investments for a retirement portfolio.

Speaking of excellent long-term investments…

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This article represents the opinion of the writer, who may disagree with the “official” recommendation position of a Motley Fool premium service or advisor. We’re Motley! Questioning an investing thesis — even one of our own — helps us all think critically about investing and make decisions that help us become smarter, happier, and richer, so we sometimes publish articles that may not be in line with recommendations, rankings or other content.

Fool contributor Adam Othman has no position in any of the stocks mentioned. The Motley Fool owns shares of and recommends Constellation Software. The Motley Fool owns shares of Lightspeed POS Inc.

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