MAKING THE CHOICE: RRSP OR TFSA

The use of either Registered Retirement Savings Plans (RRSP) or Tax Free Savings Accounts (TFSA) to save and invest is based on your unique objectives and personal circumstances. It is therefore important to understand the features of and differences between these two popular products, prior to making the decision to use either one or both of them. 

RRSPs and TFSAs: A comparative review

General Description

RRSPs and TFSAs are both registered plans which provide tax advantages when saving and investing to achieve your goals. RRSPs are used solely to save for retirement, whereas TFSAs can be used to save for any purpose, including retirement. 

Eligibility

You can contribute to a RRSP once you start earning an income from employment or from other sources such as commissions, bonuses, etc.  On the other hand, you must reach the age of majority in the province or territory in which you live to contribute to a TFSA.  

Contribution Limits

  • You can contribute 18% of your previous year’s earned income to your RRSP subject to a maximum of $27,830 in 2021. However, if you did not use all of your RRSP contribution room from previous years, you can carry forward any unused amount to the current year. Therefore, your RRSP contribution limit for the 2021 taxation year is $27,830 plus any unused contribution room from previous years.  Usually, your unused contribution room is shown on your CRA Notice of Assessment. 
  • You can make a contribution to your RRSP for the 2021 taxation year up to 60 days into 2022 and still claim a deduction for 2021. 
  • You can contribute a maximum of $6,000 annually to your TFSA. As with RRSPs, you can carry forward any unused contribution room from previous years, for a maximum contribution of $81,500 in 2022. 
  • You can contribute to an RRSP up until age 71. RRSPs mature at the end of the calendar year in which you turn 71. 
  • Conversely, there is no upper age limit to contribute to a TFSA.

Tax Benefits

  • When you contribute to an RRSP, you can deduct the amount contributed from your income on your tax return, thereby reducing your taxable income and consequently the taxes you pay in the year you make the deduction. 
  • Usually, the higher your tax bracket, the more taxes you will save. If your income is low in a particular year, you may wish to carry forward the deduction for your contribution to a future year when your income is higher in order to realize a larger tax saving. 
  • Unlike RRSPs, contributions made to your TFSA are not tax-deductible. 

Tax Free Growth

  • When you invest your contributions in an RRSP you do not have to pay taxes on any investment income or capital gains as long as they remain in your RRSP. This allows your money to compound tax-free in your RRSP, allowing it to grow faster.
  • Similarly, when you invest in a TFSA, your money also grows tax free but you can withdraw any capital gains or income without having to pay taxes.  

Withdrawals

  • The taxes you save when you claim an RRSP deduction during your working years are actually deferred until you commence making withdrawals from your RRSP during retirement. Typically, your income will most likely be lower during retirement and you will be taxed at a lower rate than when you were contributing to the RRSP. 
  • If you make a withdrawal from your RRSP prior to retirement, the amount withdrawn will be taxed at your current marginal tax rate. 
  • Conversely, withdrawals from TFSAs are always tax-free. This is because TFSA contributions are made with after-tax income. 
  • When you make withdrawals from an RRSP prior to retirement, your contribution room is lost for the amounts withdrawn. 
  • Conversely, when you make withdrawals from your TFSA, any amounts withdrawn are added back to your contribution room in the following year.

Special Features

Spousal Plans

  • Providing you have the contribution room, you can contribute directly to a spousal RRSP. This strategy allows for the equalization of the registered assets of spouses prior to retirement and facilitates a more equal distribution of income during retirement, which in turn can potentially result in a lower household tax bill. 
  • There are no spousal TFSAs. Each spouse can have his/her own TFSA. 

Home Buyers Plan

  • The Home Buyers Plan allows first time home-buyers to withdraw up to $35,000 from their RRSP to purchase their home. The withdrawal is tax-free but must be repaid within 15 years. It is a useful way to have a lump sum for the down payment on a home. 
  • Any amount can be withdrawn from your TFSA to purchase a home, with no repayment requirement. 

Lifelong Learning Plan

  • The Lifelong Learning Plan allows you to withdraw up to $20,000 from your RRSP tax free over a two-year period to pay for your own (or your spouse’s) full-time education or training.  The amount must be repaid, without interest, within 10 years.
  • Any amount can be withdrawn from your TFSA to pay for education or training, with no repayment requirement. 

Making the Choice

The choice to invest in a RRSP or a TFSA is dependent on several factors, including your individual financial goals, investment horizon and tax bracket. 

Here are some things to consider:

  • RRSPs are specifically designed for retirement, which is long-term in nature. When you contribute to an RRSP, you get a tax refund based on the value of your contribution. Your investments in the RRSP grows tax free until you turn 71, at which time you will have to start withdrawing it to fund your retirement. Once you start making withdrawals, you will have to pay taxes on the amount withdrawn, usually at a lower rate than when you originally made your contributions because your income during retirement will likely be much lower.  
  • When you invest in a TFSA, you are doing so with money that has already been taxed. Therefore, you do not get a tax refund for your contributions. However, you do not have to pay taxes on any capital gains or income derived from your investments in a TFSA. You also have complete flexibility to use the money in your TFSA for any purpose and at any time. 
  • One other consideration is your marginal tax rate, which is based on your income. If you are in a high tax bracket, the tax savings you realize when you make a RRSP contribution will be greater than if you are in a lower tax bracket. Therefore, it might make sense to contribute to a RRSP if you are in a high tax bracket.  
  • Thinking along the same lines, if you are in a high tax bracket, it will take more after-tax money to make a TFSA contribution of equivalent value to a RRSP contribution since you would have already paid taxes on the amount contributed to the TFSA.  
  • In essence, TFSAs are best used for short-term investments but can also be a good complement to a RRSP, especially if you don’t have sufficient RRSP contribution room.

Disclaimer: Do Your Own Research. You should take independent financial advice from one of our professionals and/or independently research and verify, any information that you find on our Website and wish to rely upon, whether for the purpose of making an investment decision or otherwise.