TFSA vs. RRSP

Since the introduction of the tax-free savings account (TFSA) in 2009, more and more people have begun to wonder which is better—the TFSA or RRSP. Although these two accounts are similar in a few ways, each one has enough nuances to make it unique. Rather than look at this topic as the TFSA vs. RRSP debate, we prefer to think of ways to leverage the strengths of both accounts together, and find strategies to have them complement one another.

Before diving into the pros and cons of each account, and under what circumstances contributing to one is preferable to the other, let’s take a quick look at some of the characteristics of each account.

The RRSP

The registered retirement savings plan (RRSP) is a tax-deferred and tax-sheltered account used to save for retirement. You can hold various types of investments inside your RRSP, including cash, mutual funds, stocks, bonds, GICs, ETFs, and more.

Whatever money you contribute to your RRSP reduces your taxable income. For example, if you make $100,000 in a given year, you contribute $10,000 to your RRSP, and you claim the entire deduction, your taxable income effectively becomes $90,000. Any interest, capital gains, or dividends earned by the $10,000 in your RRSP grow tax-free. However, you pay taxes when you withdraw money from your RRSP because your withdrawal counts as income in the year that you take money out. There are a couple of exceptions this rule. If you participate in the Home Buyers’ Plan or the Lifelong Learning Plan, you can make a tax-free withdrawal from your RRSP.

The amount that you can contribute to your RRSP depends on how much money you’ve made in the previous year. Your RRSP contribution limit is 18% of your earned income from the previous year, up to a maximum amount determined by the CRA. The maximum contribution limit for 2016 is %strong $26,010

Earned Income Contribution Room Earned
$50,000 $9,000
$75,000 $13,500
$100,000 $18,000
$125,000 $22,500
$144,500+ $26,010

As you can see, once you begin to earn a certain amount, the contribution room you can earn is capped. If you don’t make the maximum RRSP contribution, your unused contribution room is carried forward until you turn 71.

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The TFSA

The TFSA is a tax-sheltered account. Like an RRSP, you can hold more a wide range of investments in your TFSA, including mutual funds, stocks, bonds, GICs, and ETFs, to name a few.

The money you put in your TFSA doesn’t reduce your taxable income, but any earnings generated by the investments inside your TFSA aren’t taxed. If you make $100,000 in a year and you contribute $10,000 to your TFSA, your taxable income will still be $100,000. But any interest, capital gains, or dividends earned by the $10,000 in your TFSA grow tax-free, and you can withdraw these funds at any time.

The amount you’re allowed to contribute to your TFSA isn’t dependent on the amount of income you earn. In fact, you don’t need to earn any income at all to get contribution room for your TFSA. The CRA sets annual contribution limits and every Canadian starts accumulating contribution room beginning in the year they turn 18. The annual contribution limit for 2017 is $5,500. As with RRSPs, if you don’t contribute the full amount to your TFSA in a given year your unused contribution room carries forward. Here’s an example:

Action Contribution Limit
You turn 18 in 2016 and open a TFSA $5,500
You contribute $2,000 to your TFSA in 2016 $3,500
It’s 2017 and you get an additional $5,550 in contribution room $9,000

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The Similarities

There are more differences than similarities between the TFSA and the RRSP. The main similarities are:

  • They are both registered accounts
    • Both the RRSP and TFSA are accounts that are registered with the federal government that allow you to save money on taxes
  • You have various investment options
    • Whether you choose to open a TFSA, an RRSP, or both, you have the option to put in a multitude of different investments inside them, including cash, stocks, bonds, mutual funds, and GICs. Whatever you decide to hold in your TFSA/RRSP depends on your tolerance for risk and the time horizon of your savings goals.
  • Unused contributions are carried forward
    • If, in a given year, you don’t contribute the full amount that you’re allowed to your RRSP or your TFSA, whatever unused contribution room you have is carried forward to future years, so you don’t lose out on that opportunity. RRSP room carries forward until the year you turn 71 while TFSA room carries forward indefinitely.

The Differences

Take a look at the table below for a complete snapshot of the differences between the TFSA and the RRSP

TFSA RRSP
Do you need earned income to contribute? No, you accumulate contribution room regardless of your income level. Yes, your available contribution room depends on your level of income.
How is your contribution room calculated? You start collecting contribution room from the year your turn 18—the annual limits are set by the CRA. The limit for 2017 is $5,500. Your annual maximum contribution limit is 18% of your earned income up to a maximum amount set by the CRA. The maximum contribution limit for 2017 is $26,010.
Are contributions tax deductible? No, contributions to your TFSA have no effect on your taxable income. Yes, contributions to your RRSP reduce your taxable income.
Are withdrawals taxed? No, you can withdraw funds from your TFSA at any time without any tax consequences. Yes, whenever you withdraw funds from your RRSP, they’ll be treated as taxable income for that year (with a few exceptions).
Do you regain your contribution room after you’ve made a withdrawal? You’re allowed to recontribute whatever amounts you’ve withdrawn starting in the following calendar year. No, withdrawals can’t be added back to contribution room.
What are the consequences of over-contributing? You will pay a penalty of 1% of the over-contributed amount for every month that your TFSA contains excess funds. You can make a cumulative over-contribution of $2,000 to your RRSP in your lifetime with no tax penalty. After that you’re charged 1% of the over-contribution per month.
How long can I keep my account open? You can have your TFSA as long as you live and make contributions to it indefinitely. You can only have your RRSP open until age 71. After that, you must convert your RRSP into a registered retirement income fund (RRIF), use the funds to buy an annuity, or withdraw all of the funds.

Using Your TFSA and Your RRSP Together

TFSAs are extremely flexible because you can use them for virtually any type of savings goal. You can use it as an emergency fund, to save for a down payment on a home, a new car, a vacation, or even save for retirement. It’s recommended that you use your TFSA instead of your RRSP when you’re in low tax brackets and you earn a small amount of income because TFSAs have no upfront tax benefits.

RRSPs on the other hand, are used almost exclusively for saving for retirement. You can also make tax-free withdrawals to help fund your first home purchase or to advance your education. RRSPs are most effective if you contribute while you’re in high-paying tax bracket, as contributions will help put you into a lower bracket. After you’ve retired, withdrawals from your RRSP will be a source of income, but you’ll be in a lower tax bracket compared to when you were working.