TFSA vs RRSP Complete Guide

TFSAs and RRSPs are both investing accounts that can help you save for long-term goals, not to mention take advantage …

TFSAs and RRSPs are both investing accounts that can help you save for long-term goals, not to mention take advantage of some amazing tax benefits. They’re both sponsored by the government, they have clear limits on how much you can contribute per year, and they give you the option to grow your money through stocks, exchange-traded funds (ETFs), or even bonds. 

But beyond these similarities, TFSAs and RRSPs have some notable differences, which could make one more appropriate for you over the other. What are those differences? And how do you know which one is right for you? Let’s take a look at the TFSA v. RRSP debate and find out. 

TFSA: the rundown  

A Tax-Free Savings Account (TFSA) is a tax advantaged savings account that can help you save for, well, pretty much anything. Whether you’re saving for a car, a house, or retirement, TFSAs allow you to put money aside without having to pay taxes on interest earned or investment earnings gained. You can use your TFSA contributions to invest in a wide variety of securities, including stocks, funds, GICs, or bonds. 

The biggest advantage of TFSAs is their tax-free withdrawals. Unlike the RRSP, which requires you to pay taxes on any money withdrawn in retirement, you won’t have to worry about reporting your TFSA withdrawals on your tax filings. In addition to that, you can withdraw from your TFSA at any time, whether you’re retired or not. 

With a TFSA, you have a yearly contribution limit. Contributing more than the limit could result in a penalty. But if you contribute less, your unused space rolls over into the next year.  

RRSP: the rundown 

Like a TFSA, a Registered Retirement Savings Plan (RRSP) is a government-sponsored retirement account that helps you save for the long-term, while also taking advantage of some pretty exciting tax breaks. 

Perhaps the RRSP’s most exciting tax advantage is the ability to deduct contributions from your taxable income. For high income earners, this could mean the difference between paying taxes in one tax bracket versus paying them in a lower one. In addition, you won’t pay taxes on your RRSP’s earnings. That means, whether you have your money invested in stocks, an exchange-traded fund, or a GIC, you don’t have to report gains on your tax filings.  

Though you won’t pay taxes on earnings, you will pay taxes on whatever you withdraw. These taxes depend entirely on the marginal tax rate you have when you make the withdrawal. If you withdraw money from your RRSP when you’re not earning income (say, at 70), your marginal tax rate will be much lower than the tax rate you have now, helping you save more money on taxes. 

Like the TFSA, your RRSP has contribution limits. The limits are either 18% of the previous year’s earned income or an amount specified by the CRA, whichever is less. Again, if you contribute more than the limit, you could pay a penalty, though if you contribute less, your unused contribution space rolls over into the next year. 

TFSA vs. RRSP: what’s the difference? 

To be clear, you don’t have to choose one retirement account over the other. Many Canadians use both TFSAs and RRSPs in their retirement planning strategies, taking advantage of both accounts’ tax-shelters and contribution space. 

That said, TFSAs and RRSPs have some differences you should be aware of. Below are the key differences between both retirement accounts.  

1. TFSA withdrawals are more flexible 

In the TFSA vs. RRSP debate, the TFSA has a leg-up on an RRSP in one key area: withdrawals. You can withdraw from your TFSA at any time, for any purpose, without paying additional taxes. On top of that, you can replace the amount you withdraw in the following calendar year, allowing you to hold on to your overall contribution space. 

RRSPs, however, are a different story. The money you invest in an RRSP is meant to be withdrawn much later, ideally after you turn 71. While, yes, you can withdraw money from an RRSP at any time, you’ll pay a withholding tax (in addition to income taxes) when you withdraw before 71. If you withdraw before that age, you’ll also permanently lose contribution space. 

That said, you can withdraw from an RRSP to buy your first home (up to $35,000) or to pay for full-time education (up to $10,000 per year, or $20,000 total) without paying the withholding tax. You do, however, have to replace the money you withdraw, either within two years for a home purchase or ten years for educational purposes. 

2. RRSPs give you a tax deduction 

Though TFSAs have more flexibility, they lack one major benefit found in RRSPs: tax deductions. With an RRSP, you can deduct your contributions from your taxable income. For high income earners, this could make tax bills significantly lower, not to mention help you save on income taxes in retirement. 

3. TFSA withdrawals are tax-free

When you contribute to an RRSP, you’re using what’s called “pre-tax” dollars, that is, money that hasn’t been taxed yet. While this can help you lower your taxable income for your tax filing, it comes with one caveat: you’ll have to pay those taxes in retirement. 

With a TFSA, on the other hand, you contribute with “after-tax” dollars, that is, money you’ve already paid taxes on. That money will then grow tax-free within your TFSA account, and when it comes time to withdraw it, you won’t have to pay income taxes. 

4. RRSPs have more contribution room 

Though, yes, both RRSPs and TFSAs have limits on how much you can contribute each year, RRSPs give you more space. With an RRSP. you can contribute up to 18% of your previous year’s income, or an amount set by the CRA, whichever is lower. For instance, if you earned $72,000 last year, then you can contribute $12,960 this year. 

TFSAs have contribution space, too, but it’s typically lower. For instance, for 2021, you can contribute a maximum of $6,000. In addition, each TFSA has a lifetime maximum (as of 2021, the maximum is $75,500), which could severely limit how much you set aside for retirement. 

5. TFSAs don’t expire 

Every RRSP has an expiration date — the year you turn 71. At that point you have to turn your RRSP into a Registered Retirement Income Fund (RRIF), an annuity, or take it all out as a lump sum (and pay taxes). Once you convert your RRSP into an RRIF or annuity, you’re legally required to withdraw a minimum amount each year, an amount that increases as you get older.

TFSAs don’t have this rule. You can continue contributing to your TFSA as long as you want, and you don’t have to withdraw any minimums. 

6. Many employers offer group RRSPs — with a match 

Finally, many RRSPs are offered by employers as an employee benefit. Basically, you can elect to have a certain amount taken from your paycheque and deposited into your RRSP. What’s even better is that your employer may match what you contribute, helping you save even more for retirement. 

While, yes, some group TFSA products exist, they’re far less popular than RRSPs. In sum, if your employer offers a match on an RRSP (or a TFSA), by all means — take the match. 

When should you use an RRSP? 

In general, you’ll enjoy the tax advantages of an RRSP if you’re a high income earner in a high tax bracket, and you want to save for retirement. For one, you can deduct annual contributions from each year’s taxable income, which can lower your overall tax bill. Depending on how much you contribute, you could even put yourself in a lower tax bracket, helping you save even more on taxes. 

Then there’s the future. With RRSP contributions, you’re essentially deferring income taxes. The idea is that by the time you turn 71, your income will be far lower than it is now. If that’s the case, you’ll find yourself in a much lower tax bracket, and you’ll pay less taxes on your withdrawals in retirement.

Finally, you should consider using an RRSP if your employer offers you an account — especially if there’s a match. If you don’t take the match, you’re essentially leaving money on the table. But contribute at least up to the match and you’ll take full advantage of the benefit.   

When should you use a TFSA? 

A TFSA is well-suited for low income earners, especially those who believe they will earn significantly more in the future. If you’re earning less right now, you might find yourself in a similar tax situation in retirement, or worse — in a higher tax bracket. In that case, you’re better off paying taxes now while your tax rate is lower. 

TFSAs are also well-suited for those who want more flexibility with their withdrawals. If your savings goals are mushy, if you want to save simultaneously for a house, a car, maybe a wedding — hopefully retirement — you’re better off with a TFSA. You won’t pay taxes on your money’s growth, and you won’t pay taxes on your withdrawals.

Finally, a TFSA comes in handy if you’ve maxed out your RRSP contribution space, and you still want to contribute toward your retirement. With a TFSA, you can also withdraw money before you turn 71, which could help those Canadians who want to retire before their RRSP expires. 

Foolish bottom line on TFSA vs. RRSP 

While, yes, there are some key differences between TFSAs and RRSPs, savvy Canadians should aspire to have both accounts. 

When you’re starting out, a TFSA could help you save for any financial goal, not just retirement. You’ll dodge paying taxes on investment gains, and you can withdraw money for any purpose. As you get older, and as you start to earn more income, the RRSP will start to make more sense. You’ll take advantage of the RRSP’s tax deductions, and you could pay less income tax on withdrawals when your income is lower in retirement. 

And, of course, both accounts give you a tax-sheltered vehicle to hold your investments. In this regard, the RRSP does have a slight advantage over the TFSA, as you can hold many foreign stocks in an RRSP without paying additional taxes. Other countries, such as the United States, don’t view the TFSA as a retirement account, and you’ll have to pay a non-resident withholding tax on any income you earn. But if you’re using both accounts — the TFSA for domestic stocks and the RRSP for domestic and foreign — you can maximize contribution space for investments, while also minimize your tax liabilities.