You may be surprised to learn that there really is no “right” choice between an RRSP and a TFSA – there’s only the choice that’s right for you.
That’s why when coming up with a strategy to best meet your savings needs it’s so important to have a good understanding of how these two options actually work.
For starters, here’s an at-a-glance comparison:
| Product | How it works | What it's good for |
| RRSP | The value of your contribution generates a deduction from taxable income. Any investment gains or income are sheltered from taxation – ideally until retirement when you can withdraw funds and pay tax at a lower rate because your income will (usually) be lower. | Paying for a long-term project, such as retirement when taxable income is expected to be lower than current. |
| TFSA | Unlike RRSPs, there are no tax-deferral advantages – you contribute after-tax dollars and can’t deduct them from reported income in the contribution year. That said, income and gains within, or withdrawals from, the TFSA aren’t subject to taxation, and withdrawing funds does not affect your contribution limit. |
To support other sources of income in retirement or when you might not be ready to commit those funds to longer-term plans. |
Up front: A bit of context
Before we take a closer look at these two options, here are a few quick points and caveats to keep in mind along the way:
1. TFSAs or RRSPs by themselves are registration types – not actual investments. For example, you can’t “buy an RRSP”, but you might buy a GIC or a mutual fund (investment) within an RRSP.
2. What works for you this year might not work next year, so be flexible and adjust as you go. When trying to decide how to save, you should weigh all the factors that affect your financial health now – as well as those that could affect it in future.
3. Consider where you’re at today and where you think you’ll be in future. The decision to use a TFSA or an RRSP involves taking a look at current and future estimated tax brackets, length of time to commit and also the intended construction of a retirement portfolio.
4. Create a sound retirement plan. This will help ensure your decisions are rooted in logic vs. what may just be popular out there in the market right now. You’ll also be in a better place to know what options you should be considering along the way to help you reach your goals, grow your money, and how and when to refresh your savings strategy if you need to.
Two similar situations, two different strategies
To help weigh the pros and cons, here are a few general circumstances where a TFSA contribution might be preferable to an RRSP.
1. A TFSA is a simple option to generate tax-free income in the future.
2. The benefit of an RRSP contribution is optimized when income is deducted from a high tax bracket and tax is then re-applied at a much lower rate. So, this might mean that Canadians in their peak earning years prioritize RRSP contributions over TFSA. In contrast, a young person might park savings in a TFSA and save their RRSP contribution room for a year when they have higher income, then transfer the funds to an RRSP as they move into a higher tax bracket.
3. A TFSA can also play another important role in retirement, because it can help retirees avoid income spikes when they need large sums of short-term cash. Take this example. Consider a retiree who lives in their own house and suddenly needs $50,000 for a renovation. If all their savings are in an RRSP, they would have to withdraw about $71,500 to get their $50,000 net of withholding taxes. That withdrawal would dramatically increase their taxable income for the year, which could mean Old Age Security benefits may be clawed back. They might also have to pay tax on the RRSP withdrawal beyond the withholding taxes. However, if you have money in a TFSA, you could withdraw the $50,000 – it’s not taxable income – and you have only earned your normal income for the year. And then in coming years, if you have surplus funds, you can return all or part of that money to the TFSA.
In each situation there are multiple factors to consider - your tax bracket when you put investments into your RRSP versus your anticipated income when you withdraw it. Or the chances you will need to use the money before retirement. The rule is to be in a higher tax bracket when you contribute to an RRSP and a lower one when you withdraw.
So…which one’s better? Or should you be using both? The answer really is: it depends.
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