TFSA vs RRSP: How to decide between the two

What is a TFSA?

First introduced to Canadians in 2009, the TFSA has proven to be very popular. Each year, you get an allotment of $6,000 available for your TFSA, which means that you can put that amount away, plus any rollover from previous years (assuming you were 18 or older in 2009, you have a lifetime limit of $69,500 as of 2020). This money has already been taxed—you contribute to a TFSA from your net income—so there’s no tax break at the time of contribution. But any gains you earn in a TFSA—whether it’s from a savings account, a high-growth index fund or another investment product—aren’t subject to capital gains tax, so you won’t owe any tax on your earnings when you make a withdrawal. 

What is an RRSP?

A registered retirement savings plan, or RRSP, allows you to invest up to 18% per year of your gross income, or $26,500—whichever is less—without paying income tax on that money. (If you invest with after-tax dollars, the tax will be refunded after you file your income tax return for that contribution year.) 

In this way, an RRSP allows you to defer your taxes while saving for retirement. The most important thing to understand is that you will pay tax on this money once you withdraw it. The idea is that, because you will be retired, you will be in a lower tax bracket than during your high-earning years, and so will pay less tax overall because you invested in an RRSP. 

TFSA vs RRSP: Which is better?

The “best” investment is going to depend on your individual financial situation and goals. Remember: with a TFSA, you pay tax on money you’ve earned before you make a contribution; and with an RRSP you get a tax refund now on money you contribute, but will have to pay tax later, on money you withdraw from the plan. This difference, along with your income, your investment timeline, and other factors will all contribute to making the right decision for your investment dollars. You may find that you can use both vehicles simultaneously. Read on to learn more.

1. Income and tax bracket

Which is better? The short answer:

• RRSPs if you make over $50,000
• TFSAs if you make under $50,000

Your income determines your tax bracket—the amount of income tax you have to pay—and these factors will strongly influence which investments work best for you. 

As a general rule, those making more than $50,000 annually will do well to invest in an RRSP. This is because the money you put in is tax deductible and your deductions go towards reducing what you owe. For those who make less than $50,000 per year, the deduction is less valuable, because after claiming basic tax credits, you aren’t likely to owe much income tax. In these cases, putting your money into a TFSA may make more sense.

Compare the Best TFSA Rates in Canada*

2. Time horizon

Which is better? The short answer:

• RRSPs for longer term savings goals, like retirement
• TFSAs for short or medium term savings goals, like an emergency fund or buying a car

Anytime you make an investment, it’s a good idea to identify exactly what you’re saving for. Putting away money for retirement is usually on a longer timeline than, say, your child’s education fund or a home renovation. 

Your RRSP money is earmarked for your retirement. The program is designed so that when you withdraw the money you will be earning less, and therefore in a lower tax bracket and so will pay less overall tax in your lifetime. This works well for its intended purpose but does not help you with short- or medium-term goals. That’s where a TFSA might work better, given that you can make withdrawals tax-free, and with no penalties. Money invested in a TFSA could easily be withdrawn to buy a car, for example, with no tax implications.

Compare the Best RRSP Investments*

3. Group plans

Which is better? The short answer:

• Almost always RRSPs if you get a company match (it’s free money, after all)

If you receive a matching contribution from your employer on a group RRSP or a similar tax-deferred account like a defined contribution (DC) pension plan, investing in your RRSP could be even more valuable than usual. The way employer contributions tend to work is that your company will match a percentage of your salary when you invest the same percentage, or a percentage of what you contribute—sometimes dollar for dollar. This free money is an automatic return on your investment that would be pretty much impossible to obtain through investing. 

Let’s look a little closer. An employer match of even 2% on a $70,000 income results in an extra $1,400 in your RRSP—and your employer’s portion of the contribution may also count towards your RRSP deduction for tax purposes. This is a double benefit and will likely tilt your preference in favour of a workplace account over other savings options unless the match is low, or the investment options are terrible. 

4. Buying your first home or saving for education

Which is better? The short answer:

• Usually RRSPs, due to the availability of the Home Buyers’ Plan and Lifelong Learning Plan

Remember how your RRSP is designed for your retirement? There are a few notable caveats to that, in the form of the Home Buyers’ Plan, and the Lifelong Learning Plan. 

The Home Buyers Plan (HBP) allows eligible home-buyers to withdraw up to $35,000 from their RRSP to put towards their purchase. The withdrawal is tax-free and must be repaid within 15 years. This is a great way to access a large lump sum, like for a down payment and, though it must be repaid, the “loan” is interest-free.  

Similarly, the Lifelong Learning Plan (LLP) is a program that allows you to use your RRSP savings towards your own (or your spouse’s) full-time education or training, up to $20,000 over two years. The amount must be repaid within 10 years.

5. In retirement

Which is better? The short answer:

• Almost always RRSPs (but depends on your income, as covered in section 1)

Withdrawals from TFSAs are always tax-free, whether you’re working or retired. Withdrawals from RRSPs are always taxable. If you’re in retirement, you are likely in a lower tax bracket than prior to your retirement, which means that RRSP withdrawals will be taxed at a lower rate than when you earned the money you originally contributed. Tip: If you find that you have a tax refund, you can maximize it by reinvesting the balance into a TFSA.

When saving and planning for retirement, it pays to take a considered and long-term approach with your decisions—and to personalize them. Whether on your own or with a professional, retirement planning can help validate your choices and assist you to set targets for the future.