Most individuals saving for retirement will hold investments inside one of these two types of investment accounts. They aren’t the same as a bank account – think of them as a basket where you keep a variety of investment assets like the ones mentioned above.
RRSP – Registered Retirement Savings Plan
This is a registered account used only for retirement savings.
TFSA – Tax Free Savings Account
This savings account can hold all the same types of investments as the RRSP, but you do not receive a tax deduction – contributions are made from after-tax income.
Side by Side Comparison:
No tax deduction at the time of your contributions.
Your contributions are tax-deductible at the time of deposit (you don’t pay tax on money you deposit to an RRSP in the tax year).
Income earned inside TFSA is not taxable
Income earned in RRSP is taxable in future
Original contributions AND income earned are not taxed when withdrawn
Entire withdrawal amount is taxed; both original contributions (because you saved the tax when you deposited), and income earned
TFSA withdrawals do not affect taxable income in the year of the withdrawal; so, no effect on income-tested benefits like Old Age Security and Guaranteed Income Supplement.
RRSP withdrawals are taxable income; if your withdrawals cause you to exceed income thresholds, benefits like Old Age Security and Guaranteed Income Supplement may be reduced.
Easy to withdraw at any time without penalty or tax withholding
Can withdraw at any time, but keep in mind tax will be withheld
Static contribution limit set by government yearly – penalties for exceeding
Contribution limit based on income and annual maximum – penalties for exceeding
When is a TFSA better?
If your income currently is low enough, or you have enough tax deductions available (such as tuition deduction, medical or childcare expenses, etc) that you don’t need any more deductions to reduce your tax owing to zero.
If your income is in a low tax bracket, and you expect that you will be in a higher tax bracket when you withdraw the savings. You pay tax in your lower bracket before depositing money to a TFSA, and then pay no tax when you withdraw.
If you expect to need withdrawals earlier. You can withdraw without having to worry about withholding tax at the time of withdrawal, because the taxes have already been paid.
You don’t want limits on how long you can save. By investing in a TFSA, you can choose to leave the funds invested. With an RRSP, you are legally obligated to withdraw a minimum amount per year starting at age 72.
If an RRSP might be more beneficial, but your RRSP contribution limit has been exceeded for the year.
When is a RRSP better?
If you are in a situation where you can afford to contribute, and the tax deduction is desirable now. For example, if you know that you will owe personal income tax but you could contribute enough to an RRSP before the contribution deadline to erase your tax liability.
If you are in a high tax bracket now, and you expect that you will be in a lower tax bracket when you withdraw the savings. You avoid being taxed now at the higher rate, and are instead taxed at a lower rate when you withdraw in the future.
If you want to invest a lot of money in foreign stocks. Retirement accounts are exempted from non-resident withholding tax on income from US sources, but the Internal Revenue Service in the USA doesn’t recognize the TFSA as a retirement account, so they’ll withhold non-resident taxes on your US income inside a TFSA.
If you and your spouse have significantly different income levels. The higher income spouse can contribute to the lower income spouse’s RRSP, allowing a more even split of the money saved so that in retirement you can optimize which account you draw from for large purchases.
If a TFSA might be more beneficial, but your TFSA contribution limit has been exceeded for the year.
In reality, the best investment strategy is going to be a combined approach using both TFSA and RRSP accounts. Prioritize one or the other based on what we’ve outlined above, and then if you run out of contribution room in one, direct excess contributions to the other. Your personal financial planner will be your best resource for finding this balance!