The classic debate of which account to maximize, a Tax-Free Savings Account (TFSA) or Registered Retirement Savings Plan (RRSP), is never-ending. But the truth is, both TFSA and RRSP have a role to play in your portfolio depending on your financial situation. Financial products are prepared to fill gaps around financial needs. How you use these products depends on what gap you are trying to fill.
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Why is RRSP not a good income engine
With passive-income investing, you are trying to fill a financial gap to help pay for daily expenses. You don’t want the Canada Revenue Agency (CRA) to take a large bite from that income. This makes an RRSP an inefficient income engine for two reasons.
First, RRSP withdrawals are subject to withholding tax, ranging from 10% for withdrawals up to $5,000 to 30% for withdrawals above $15,000. If your taxable income is above 30%, you pay additional tax during tax filing. If you withdraw $30,000 annually, you will receive $23,000 after tax. This excludes additional tax if you fall into the higher tax bracket.
| RRSP Withdrawal | Tax rate | Tax Withheld |
| $5,000 | 10% | $500 |
| $10,000 | 20% | $2,000 |
| $15,000 | 30% | $4,500 |
| $30,000 | $7,000 |
Second, the RRSP amount once withdrawn cannot be reinvested. You permanently lose the RRSP contribution room, reducing your space for tax-free investment.
Why is a TFSA a good income engine
TFSA overcomes the RRSP barriers. It allows you to withdraw your money tax-free. A $30,000 TFSA withdrawal gives you $30,000 after tax.
The withdrawals from your TFSA are added back next year on January 1, although contribution room might be updated in February or March. For instance, if you withdraw $5,000 in 2025, your 2026 TFSA contribution room is the $7,000 new contribution limit for 2026 plus $5,000 from the 2025 TFSA withdrawals plus any unused contribution room.
The TFSA gives you another brownie point of tax-free withdrawals. The amount you withdraw need not be reported in your taxable income. This means the CRA retirement benefits calculated on your taxable income — Old Age Security (OAS) and Guaranteed Income Supplement (GIS) — are unaffected.
The above three reasons make TFSA an ideal instrument to build your passive-income portfolio.
Two TSX stocks to build your TFSA income portfolio
If you directly invest in dividend stocks, you will only get the yield. Your TFSA contribution room is limited, but you can increase it through portfolio rebalancing and reinvesting. Instead of investing the $7,000 TFSA contribution in a dividend stock, consider buying a growth stock like Celestica (TSX:CLS), which has the potential to double your money in two years on the back of an artificial intelligence (AI) rally. You can book profits by selling a portion of your holdings and reinvest that money in a high-growth dividend stock like Canadian Natural Resources (TSX:CNQ).
Celestica stock for growth
Celestica stock has already grown 745% over the last two years, and it has more room for growth as it expands its Enterprise segment into AI compute components. The previous growth was driven by Ethernet Switches used by hyperscalers and communications companies. The next leg of compute and storage devices would generate higher profits. It already has three hyperscaler customers, and the semiconductor industry is a small community where one contract attracts others.
The current 30% dip from its peak is an opportunity to buy and hold the stock for the next three to five years as Celestica rides the AI infrastructure wave.
Canadian Natural Resources for income
Canadian Natural Resources has a 3.74% dividend yield, but its key attraction is strong dividend growth history. It grows its dividend between 2% and 50% annually as the company embeds the dividend amount in the breakeven price. It has been aggressively buying oil sands reserves and using production output to pay off debt. Once net debt falls below $13 billion from the current $14.5 billion, it will use 100% of its free cash flow to buy back shares. A reduced share count will help the company accelerate dividend growth.
