TFSA vs RRSP: Which is better for you and why?

By: Updated: August 17, 2021

Topics: , ,

The TFSA and RRSP are both great investment vehicles. In this article, we’ll explain the difference between TFSA and RRSP and discuss which may be the better option depending on your situation. However, rest assured that you can’t go wrong by saving some of your money using either of these tools.

 

The Tax-Free Savings Account (TFSA)

The TFSA is a way to save for any purpose, including a home, retirement or simply to take a once-in-a-lifetime vacation. While you do not receive a tax deduction for your contribution, the investment income inside the account accumulates tax-free. You do not have to pay tax when you make a withdrawal.

TFSA contribution limits: The maximum you can put into your account in 2021 is $6,000. In addition, if you have not made the full contribution in the past, you can take advantage of any unused contribution room. Check your CRA account for details.

Withdrawal rules: You can withdraw funds from a TFSA at any time without paying any tax. You can also keep the money in the account as long as you live (there are no minimum withdrawal requirements like there are for RRSPs).

 

The Registered Retirement Savings Plan (RRSP)

As its name suggests, the RRSP is primarily a vehicle to save for your retirement. However, there can be some other uses so read on for details.

Contribution limits: You can save up to 18 percent of your previous year’s income, minus any pension adjustments. There is a limit of $27,830 per year, which is the amount you could contribute if you earn more than $154,000 annually.

Withdrawal rules: You can withdraw funds from your RRSP at any time – but you will face a withholding tax and have to claim the monies as income on your tax return. This is a key difference between RRSP and TFSA. You are not permitted to have an RRSP after the end of the year in which you turn 71; after that, you must withdraw the funds or open a Registered Retirement Income Fund (RRIF) or purchase an annuity. There are minimum annual withdrawal requirements from a RRIF depending on your age; for example, the minimum at age 71 is 5.28 percent.

Withdrawals for other purposes: You are allowed to take out funds from your RRSP, as long as you are willing to pay the tax. In addition, the Canadian government does permit you to withdraw funds under its first-time home buyers’ plan. You must pay these monies back into your RRSP within 15 years or face a tax penalty.

 

Comparison chart: What’s the difference between RRSP and TFSA

 

RRSP

TFSA

Contribution limit

18% of previous year’s income
Maximum of $27,830

$6,000
Plus unused contribution room

Tax deduction

Yes

No

Investment growth

Tax deferred

Tax free

Withdrawals

Taxable. Tax withheld on each withdrawal

Tax free

Purpose

Saving for retirement

Saving for any purpose

Spousal plan

Contribute directly to their plan

Give money so they can contribute

Minimum withdrawals

Must start withdrawals by age 71 (5.28%)

No rules. TFSA funds can be held until your death

 

So, now that we’ve discussed the basics of the two savings vehicles, let’s look at the TFSA vs RRSP pros and cons.

 

Is it better to invest in RRSP or TFSA?

It depends! Ideally, you can invest in both but the tax advantages really depend on your personal situation. Here are a couple of examples of the difference between RRSP and TFSA:

  • You are 25 years old and just starting out on your savings journey. You earn $30,000 per year and are not sure how you will use your savings. In this case, you will be better off opening a TFSA. Your taxable income is not that high so the tax deduction for an RRSP contribution would be minimal. As well, the TFSA offers plenty of flexibility – you can use the funds to buy a house, further your education or take a trip.
  • You are 50 years old and want to start saving for retirement. You earn $100,000 per year. It’s definitely time (perhaps past time!) to open an RRSP. With your relatively high income, you will receive a solid tax deduction. You can use these funds to top up your RRSP or perhaps even open a TFSA. In this case, RRSP wins in the TFSA or RRSP race.

 

Should I have both RRSP and TFSA?

Ideally, yes. One of the TFSA vs RRSP pros and cons is that the TFSA offers more flexibility. If you have a financial emergency and need some cash (for a new roof or a dental bill, for example), you can withdraw funds from your TFSA. There is no tax owing. If you only have an RRSP and must make a withdrawal, you will have a withholding tax deducted at source. And you will need to report the income on your income tax return – you could even end up pay more tax in addition to the withholding tax.

 

TFSA vs RRSP vs Personal Savings Accounts

Non-registered accounts, such as for personal savings, are another option. However, these accounts do not deliver the tax benefits of a TFSA or RRSP. So, are there situations where you may wish to keep funds in a non-registered account? Definitely. For example, if you have maximized your TFSA contributions and still wish to have to have an emergency fund, you can open a non-registered account. Just be careful about how you invest these funds as some savings vehicles have waiting periods before you can cash out.

 

TFSA vs RRSP Comparison Chart

Here’s an example of the difference between RRSP and TFSA with a hypothetical $1,000.

 

TFSA

RRSP

Income

1,000

1,000

Income tax (30%)

300

0

Net contribution

700

1,000

Value after 30 years at 6%

4,020

5,743

Income tax on withdrawal (30%)

0

1,723

Net

4,020

4,020

 

TFSA vs RRSP Calculator

A number of financial institutions offer a calculator that allows you to see the differences between TFSA or RRSP. You can also see how your contribution can be expected to grow over the years until your retirement or when you need your TFSA funds.

Here's a sample calculator from RBC.

 

TFSA vs RRSP Forums

You can also get a wide range of views about TFSA vs RRSP pros and cons on this Reddit forum. Watch out though: Not everyone on Reddit is an expert, although they are always eager to share their opinions!

 

Are you incorporated in Canada?

Small business owners and incorporated individuals in Canada can use a Health Spending Account (HSA) to save on their medical expenses. An HSA is a cost effective alternative to traditional health insurance. The plan covers a wide variety of health and dental expenses. You could save thousands of dollars in taxes with an HSA.

 

Find out more about Health Spending Account (HSA), download my free guides:

Download the HSA Guide for Incorporated Individuals

Download the HSA Guide for a Business with Staff

What's in this article


Subscribe to thge small buisness outlook

Subscribe to the blog