The difference between RRSPs and TFSAs

It’s a battle a decade in the making. In one corner, it’s the senior citizen of retirement accounts, the RRSP. In the other, it’s the relative newcomer, the 10-year-old TFSA. But which one is best for you? Well, it depends.

RRSPs and TFSAs can both be used as a place to save for retirement or a down payment on a home, but TFSAs are much more flexible. Before we get into that, let’s review how each account works.

RRSP review

An RRSP is primarily used for retirement savings. It’s been around since 1957 and was created as an option for Canadians that didn’t have a regular work pension, which was much rarer back in the day.

The amount you’re allowed to save in an RRSP each year depends on your income. Usually, the cap is 18% of your pre-tax income. If, for example, you made $50,000 in 2017, you can contribute $9,000 ($50,000 x 18% = $9,000) in 2018. But, if you made $200,000, you can’t contribute 18% because the maximum amount is capped at $26,230 for 2018.

If you don’t put in the maximum amount, your unused contribution room carries forward until you turn 71. If you don’t have income or unused contribution room, you can’t contribute to an RRSP. You can find how much contribution room you have on your latest notice of assessment, calling the Canada Revenue Agency (CRA), or logging into your CRA account.

When you deposit money into an RRSP, it reduces the amount of tax you pay. Let’s assume you earn $60,000 and make a contribution of $5,000. If your marginal tax rate is 29.65% (which it is in Ontario), you’ll receive a tax refund of $1,482.50.

When you withdraw money from an RRSP, the amount is taxed except in two instances. If you participate in the Home Buyers Plan or the Lifelong Learning Plan, you’re allowed to take out a certain amount without being taxed. Withdrawals for these plans must be paid back. Withdrawals for any other reason can’t be paid back and you don’t regain contribution room.

In the year you turn 71, you must either convert your RRSP into a registered retirement income fund (RRIF) or an annuity. There’s also the option to withdraw all the money at once, but that might be taxed at a very high rate if your RRSP balance is high. You’re no longer allowed to contribute to an RRSP when you turn 72.

TFSA primer

A TFSA can be used for a number of financial goals, such as retirement, saving for a home, a well-deserved vacation, or even as an emergency fund.

Everyone over the age of 18 receives the same amount of contribution room every year. In 2019, the limit is $6,000. If you were eligible for a TFSA when it was introduced in 2009 and have never contributed to one, you will have $63,500 in contribution room. You can find how much room you have by logging into your CRA account or by calling them.

Like an RRSP, the money you contribute grows tax free. But unlike an RRSP, you don’t receive a tax refund for contributions.

However, you never need to pay tax when you make a withdrawal. If you use the money as part of a down payment on a home or to help fund your post-secondary education, there’s no obligation to repay the money you withdrew.

Also, your contribution room rises in the following year after you make a withdrawal. For example, if you max out your TFSA and you withdraw $5,000, you’ll be allowed to contribute that amount plus next year’s limit (which is likely to be $6,000).

When you reach 71, you don’t need to do anything with TFSA. Your contribution room continues to grow every year until you pass away.

RRSPs vs. TFSAs: Which is best for you?

The answer depends on your income and what you plan on doing with the money.

If you’re in a high tax bracket, you definitely want to contribute to an RRSP. That’s because you’re more likely to be in a lower tax bracket in retirement and your withdrawals will be taxed at a lower rate.

If you’re in a low tax bracket and you contribute to an RRSP, it’s possible you might end up in a higher tax bracket when you start making withdrawals in retirement. A TFSA will make more sense in this case.

As your income grows and you move into a higher tax bracket, it will be better to contribute more in an RRSP and less in a TFSA. If you have enough income, you may be able to max out both.

If you’re saving for a home, you can save in an RRSP or TFSA. However, you’re obligated to pay back the amount you withdraw when you participate in the Home Buyers’ Plan over a 15-year period. When you don’t pay back the required amount in any given year, it’s considered taxable income. If you plan on using the money for a car, a vacation, or a renovation, a TFSA is the best choice because you won’t be taxed on withdrawals.

The bottom line

RRSPs and TFSAs are both great options for saving for retirement. Which one you use will depend on your income and what you plan on doing with the money you saved.

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