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With TFSAs and RRSPs, Canadians have great options for saving and investing their money. And in some respects, the two accounts are quite similar. Yet the important difference between RRSPs and TFSAs lies in the tax rules for each.

The more you know about how each works, the more informed choices you can make if you’re trying to decide which one to use.

Are RRSPs or TFSAs more popular with Canadians?

RRSP usage has declined somewhat in popularity when compared to TFSAs, according to Statistics Canada. In 2020, RRSPs made up 31.5% of total contributions to registered accounts, and TFSAs made up 51.8%. Stats Canada says that one reason for this could be that TFSAs are appealing to people across different income brackets. Once higher income people have maxed out their RRSP contribution room, they can use TFSAs to avoid being taxed on their income rather than letting it sit in a taxable non-registered account. On the other hand, lower income Canadians may find that RRSPs don’t necessarily benefit them tax-wise, and TFSAs offer the option to withdraw their money penalty-free.

The benefits of RRSPs and how to use them

RRSPs have been around for decades and are specifically aimed at helping Canadians save for their retirement.

Every year, Canadians who file a tax return may contribute either 18% of their earned income, or up to the annual maximum contribution limit, which is $30,780 for 2023. Unused deduction room is carried forward into the next year, so you can catch up if you’ve fallen behind.

The benefit of RRSPs is that contributions are tax-deductible, which means that they basically reduce your taxable income. Depending on a person’s situation, making a contribution and claiming the deduction can result in receiving a tax refund. 

RRSP investment options

Making an RRSP contribution and claiming the deduction on your taxes is important. But the next step with an RRSP is deciding where to invest the money you have in it. Canadians have many investment options when it comes to assets that are RRSP-eligible. These include:

Other than a tax deduction, the other major benefit of RRSPs is that so long as the money is in the account, investment earnings grow on a tax-free basis. In other words, capital gains and dividend/interest income don’t need to be reported on your income tax return.

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Eventually, however, tax must be paid. By the end of the calendar year in which you turn 71, the money from an RRSP must be withdrawn, or turned into either an annuity or a registered retirement income fund (RRIF). In all three cases, you’ll start to draw on your retirement savings and pay tax on the income.

Withdrawing from an RRSP

If you withdraw money from your account before you retire, it’ll have to be reported as income unless you’re withdrawing the funds to buy a home using the Home Buyers’ Plan (HBP) or to further your education by taking advantage of the Lifelong Learning Plan (LLP).

How to use a TFSA

With RRSPs, you contribute pre-tax dollars into the account and only pay tax when it’s ultimately withdrawn. TFSAs work in the opposite way.

Every year, the government allows Canadians 18 years or older to contribute a certain amount ($7,000 in 2024) to a TFSA.

Unused contribution room carries forward, meaning you don’t miss out on the potential benefits just because you didn’t make the full contribution in a given year. If you were over the age of 18 in 2009 when TFSAs became available and had a valid social insurance number, you should have $95,000 in total lifetime TFSA contribution room.

TFSAs are allowed to hold pretty much the same investments as RRSPs. The list above shows what you can buy and hold in your account. A BMO Annual Investment Survey found that 53 per cent of TFSA owners have investments in their account. The remaining 47% hold cash, and BMO says this group “could be missing out on opportunities for enhanced tax-free growth.”

TFSA benefits

Unlike RRSPs, you can contribute to a TFSA as long as you live. In addition, you can make tax-free withdrawals. Importantly, when you withdraw money from a TFSA, you don’t lose the contribution room. This matters because it takes into account any rise in the value of your account. For instance, if the investments in your TFSA have appreciated in value to $150,000 and you withdraw $50,000, you retain that $50,000 as contribution room. The only limitation is you must wait until the next year in order to recontribute that amount.

To summarize, here’s a chart showing how RRSPs and TFSAs compare:

So, should you use a TFSA or RRSP?

Some Canadians are able to contribute the maximum amounts to their RRSPs and TFSAs. But what if you’re looking at each one and can’t decide what’s better? How should you decide which is the better fit for a contribution?

A lot depends on the tax bracket you’re currently in and where you think you’ll be in retirement. For RRSPs, one of the reasons they’re advantageous is that for most people, their marginal tax rate in retirement will be less than it is when they’re working. Thus, an RRSP contribution is a tax deferral. You take pre-tax money, invest it, and when tax is to be paid in retirement, the marginal tax rate is usually lower.

What if you expect your marginal tax rate to be higher in retirement? In that case, contributing to a TFSA over an RRSP might make more sense. You’ll be making the contribution with money on which tax has already been paid at a more favourable rate. And by going with a TFSA, you won’t have to count withdrawals as income if you’re in a higher tax bracket.

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