In Canada, we’re fortunate to have two of the best retirement accounts in North America or, dare I say, the world: the Tax-Free Savings Account (TFSA) and the Registered Retirement Savings Plan (RRSP). In fact, we’re the only country in America (both North and South) that has made the world’s top 10 pension systems several years in a row.
Our retirement accounts are so good, in fact, that it can be incredibly difficult to choose between them. Of course, a solid retirement plan will make use of both. But, hypothetically speaking (or not if you don’t have a lot of retirement savings), if you had to choose one over the other, which would make the better choice for you: a TFSA or an RRSP?
Let’s take a look at when you should use a TFSA and when you’re better off with the RRSP.
Want more flexibility? Go with the TFSA
If there’s one thing that sets the TFSA apart from the RRSP, it’s flexibility. Unlike RRSPs, which are really designed for long-term retirement savings, TFSAs have no withdrawal restrictions. You can take money out of your account to buy anything, whether that’s retirement, a house, a car, a vacation, or a new set of skis. Whatever money you put into your TFSA will grow tax-free, and you won’t have to pay taxes when you withdraw it. In addition, the money you withdraw can be recontributed to your account the year after you take it out.
The RRSP is flexible, too, but only for two things: home buying and funding your education. Each of these have withdrawal limits, and you have to replace the money you withdraw (it’s more or less like a loan). If you withdraw money from your RRSP for anything else, you’ll pay a withholding tax on your withdrawal. Additionally, you have to report your withdrawal as income on your tax filing.
So, if you want more flexibility (read: pay less in taxes), go with the TFSA.
Want more contribution space? Go with the RRSP
With an RRSP, your maximum contribution is either 18% of your previous year’s income or $27,830, whichever is lower. For instance, if you earned $100,000 last year, you could contribute $18,000 this year, but if you earned $200,000 last year, then you could only contribute $27,830 (18% would be $36,000).
That’s a heck of a lot more than the TFSA’s maximum contribution limit, which, for 2021, is $6,000.
Both accounts roll unused contribution space forward, meaning if you can’t contribute the max, you’ll still have a chance to fill it up in the future. However, if your goal is to save a tonne of money for retirement — as in, you’re behind or you want to retire early — the RRSP is the right account for you.
Don’t want to pay taxes in retirement? Go with the TFSA
Of course, saving lots of money in an RRSP has its consequences — tax consequences, that is.
With an RRSP, you contribute pre-tax dollars, meaning money that hasn’t been taxed. The CRA allows you to defer paying taxes until you withdraw money in retirement.
At that point, you’ll pay taxes on your withdrawals at your marginal tax rate. Of course, since you’re retired, you won’t be earning as much income (in theory, at least). So, your marginal tax rate will be lower than it is now. Still, you’ll pay taxes, and there’s no way around that.
With a TFSA, you contribute with after-tax dollars, meaning you’ve already paid taxes on your contributions. The CRA won’t double tax you, so you can withdraw from your TFSA tax-free. If you like the idea of paying no taxes in retirement, the TFSA might be a good amount for you.
Want a tax deduction now? Go with the RRSP
Paying no taxes in retirement sounds splendid. But the RRSP has one final leg-up on the TFSA: tax deductions.
Your RRSP contributions are tax deductible, so they can lower your taxable income by a substantial amount. You may pay taxes later in retirement, sure, but if your contributions can put you in a lower tax bracket today, you may pay less in your overall tax bill. That’s why it’s super wise to consult a tax or financial advisor when you’re planning out your retirement, as they may know something you don’t about how to lower your tax liability.
If you think your contributions can lower your taxes now, by all means — go with the RRSP.
Good news: You don’t have to choose
The good thing about Canada’s retirement accounts is that you don’t have to choose between them. For beginners or low-income earners, I’d recommend starting with a TFSA. Try to max out your contributions, and when you reach a point when you want to contribute more (as in, you got a raise or you’re getting more serious about retirement), open up an RRSP. Alternatively, if your employer offers an RRSP with a match, definitely take the match. You don’t want to leave free money on the table.