TFSA or RRSP: Which One Should You Choose?

A Tax-Free Savings Account, or TFSA, is a registered account that can hold savings and different types of eligible investments.

TFSA contributions are not deductible from taxable income. In return, investment income and gains earned inside the account, as well as regular withdrawals, are generally tax-free.

A TFSA is not just for savings

Despite its name, a TFSA does not have to be a simple savings account. It is primarily a tax wrapper. Your return depends on the investments held inside the account rather than on the TFSA itself.

Withdrawals make the TFSA flexible

When money is withdrawn from a TFSA, the amount is generally added back to your contribution room on January 1 of the following year. However, you should not automatically recontribute the amount during the same year unless you have enough available contribution room.

A Registered Retirement Savings Plan, or RRSP, is primarily designed for long-term and retirement savings.

An eligible RRSP contribution can generally be deducted from taxable income. Investment income can grow inside the plan without being taxed immediately, while regular withdrawals are generally taxable.

A simple example

Suppose your income is $80,000 and you claim an eligible $10,000 RRSP deduction. In a simplified example, that deduction can reduce the income used to calculate your tax. The actual tax savings depend on factors such as your marginal tax rate and overall tax situation.

A tax refund is not free money

An RRSP generally does not eliminate tax; it defers it. A contribution may reduce your tax today, but money withdrawn later is generally added to your taxable income.

Both accounts allow investments to grow in a tax-advantaged environment, but the tax benefit occurs at different times.

An RRSP deduction does not necessarily have the same value when your income is $35,000 as when it is $100,000. The higher your marginal tax rate, the more valuable a deduction may be.

This is why some people choose to prioritize their TFSA while their income is relatively low and make greater use of their RRSP later as their income and marginal tax rate increase.

However, avoid reducing the decision to a simple rule such as “low income equals TFSA” and “high income equals RRSP.” Income-tested benefits, tax credits, financial goals and future income can also affect the decision.

A TFSA may be especially useful in situations such as:

• Your current income is relatively low.
• You are early in your career.
• You want relatively easy access to your money.
• You are saving for several different goals.
• You may need the money before retirement.
• You expect your tax rate to be higher later.
• You have already used much of your RRSP contribution room.

TFSA income and withdrawals generally do not affect eligibility for federal income-tested benefits and credits, which can also become important later in life.

An RRSP may deserve greater attention when:

• Your current taxable income is high.
• Your marginal tax rate is relatively high.
• Retirement is your main savings goal.
• You expect a lower tax rate when you withdraw the money.
• You want to reduce your current taxable income.
• You plan to save or invest the tax savings generated by your contribution.

How you use the tax savings can matter significantly. A $2,000 tax saving that is invested can have a very different long-term effect from $2,000 that is immediately spent.

Withdrawing from a TFSA

A regular TFSA withdrawal is generally tax-free. The amount withdrawn is normally added to your contribution room the following year.

Withdrawing from an RRSP

A regular RRSP withdrawal is generally taxable, and the contribution room that was used is normally not restored. Tax may be withheld when you withdraw money, but this withholding does not necessarily represent your final tax liability for the year.

The best account often depends on the goal. Canada has several other registered plans designed for specific financial objectives.

TFSA, RRSP, FHSA, RESP and RDSP primarily describe tax structures. They do not automatically determine what your money is invested in.

Depending on the account and financial institution, different eligible investments may be held inside. You can therefore choose an account that fits your situation while still holding an investment that does not match your time horizon, risk tolerance or financial objective.

For many Canadians, the best answer is not necessarily TFSA or RRSP. The two accounts can play complementary roles.

Someone might prioritize a TFSA while their income is relatively low, increase RRSP contributions as their income rises, use an FHSA while saving for a first home and eventually use a non-registered account after maximizing the registered accounts that fit their goals.

A financial strategy can therefore evolve as your income, goals and stage of life change.

If you remember only a few ideas from this guide, remember these:

• TFSA contributions are generally not deductible, but regular withdrawals are generally tax-free.
• An eligible RRSP contribution can reduce your taxable income today, but regular withdrawals are generally taxable later.
• Your current and future tax rates can strongly affect the comparison.
• A TFSA withdrawal generally restores contribution room the following year, while a regular RRSP withdrawal generally does not.
• The account and the investment are two separate decisions.
• You do not necessarily have to choose between a TFSA and an RRSP; the two can complement each other.