TFSA vs. RRSP: Which is Better For You?

We are lucky as Canadians to have access to a variety of tax-sheltered accounts (including RRSP and TFSA) that we can use to grow our retirement savings.

Deciding between a TFSA vs. RRSP can be a tricky decision to make. Both accounts work well for the general purposes they were intended for, but based on your specific circumstances, it may be in your best interest to choose one account over the other.

Before digging into when you should choose a TFSA account over an RRSP, let us quickly summarize what they both offer:

TFSA Overview

The Tax-Free Savings Account, popularly known as TFSA, is a savings tool introduced by the government in 2009.

It allows Canadians who are 18 years of age or older to save or invest a certain amount per year based on contribution limits that are announced annually.

For 2021, the annual contribution amount is $6,000.

If you are unable to use up your contribution room for the year, you can carry it forward to future years indefinitely. If you have been eligible to contribute to a TFSA since its inception and have never contributed, your contribution room is now $75,500.

The investments you can hold in your TFSA account are plentiful, including stocks, bonds, ETFs, mutual funds, index funds, GICs, cash, and more.

Earnings (or interest) realized on your TFSA investments/savings are sheltered from taxes for life. However, unlike the RRSP, your initial contributions to the account are not tax-deductible.

Related: 5 Ways To Invest Your TFSA

RRSP Overview

The Registered Retirement Savings Plan is an account introduced in 1957 that allows Canadians to save towards retirement using tax-deductible contributions.

Each year the government stipulates the maximum portion of “income” that you can contribute to your RRSP account.

For 2021, it is 18% of your earned income up to a maximum of $27,830.

Like the TFSA, unused contribution room can also be carried forward to future years, however, you can no longer contribute to an RRSP after age 71. Earnings on your RRSP investments are sheltered from taxes until when you withdraw funds.

Unlike the TFSA, your contributions to an RRSP account are tax-deductible, meaning that you do not have to pay taxes on the portion of the income you contribute to the account.

Related: How to Generate Income From Your RRSP in Retirement

TFSA vs. RRSP (With Examples)

Going back to our original question, “Which account should you choose between the RRSP and TFSA?”

In an ideal world, you should choose both accounts and max out your contributions to both of them. However, that is not always feasible because the average Canadian may not just have enough funds to max out both accounts.

So, if you have to choose between contributing to the TFSA or the RRSP, here are a few points to use as a guide:

1. Your Tax Bracket Now and In Retirement

In general, if your tax bracket (or marginal tax rate) now is likely going to be higher than your tax bracket in retirement, an RRSP account is preferable to a TFSA.

The reasoning behind this is that your tax savings now (through tax-deductible contributions) will be more than the taxes you pay in retirement when you start withdrawing funds from your RRSP.

For example, assuming you earn $95,000 in Manitoba (marginal tax rate of 43.40%) and contribute $10,000 per year. If you retire in 30 years with an income of $60,000 and a marginal tax rate of 33.25%, what’s your first $10,000 contribution going to look like under both accounts?

In this scenario, you are better off maximizing your RRSP before your TFSA:

*When the tax rate is lower in retirement, the RRSP wins. 

On the other hand, if your marginal tax rate now is lower than what it will be when you are retired, it generally makes sense to prioritize your TFSA account over your RRSP.

This is because your tax savings now will be less than the taxes you are required to pay when you withdraw funds from your RRSP in retirement.

For example, let us assume a reverse of the example above i.e. that your current marginal tax rate is 33.25% and your tax rate in retirement is 43.40%. For the same contribution of $10,000 in an RRSP vs. TFSA, you have:

*When the tax rate is higher in retirement, the TFSA comes out on top. 

2. If You Have an Entry-Level Job

When you are just entering the workforce and earning a starting (small) salary, it is preferable for you to prioritize your TFSA. A small salary means a lower marginal tax rate and lower tax savings on your contributions.

For example, if you earn $35,000 in Manitoba, your marginal tax rate is 27.75%. This means that a contribution amount of $5,000 to your RRSP will save you $1,387.50.

Compare that to a higher-income earner who makes $75,000 and a marginal tax rate of 37.90%. For the same RRSP contribution amount of $5,000, they generate tax savings of $1,895 (37% more).

Contributing to a TFSA does not affect your RRSP contribution room…it will continue to grow and can be used up when your income and marginal tax rate increase and you can get more in tax deductions.

3. Based on Your Income in Retirement

When you withdraw funds from your RRSP in retirement, it counts towards your overall taxable income and can impact other income-tested benefits you qualify for.

For example, if your total retirement income in 2021 exceeds $79,054 (a combination of pensions, RRSP, CPP, OAS…and excluding TFSA), the government will claw back some of your OAS benefits (at the rate of 15 cents for every $1 over the threshold amount).

However, if your total income excluding TFSA is $60,000 and you withdraw $19,054 from your TFSA (for an overall income of $79,054 for example), you will not suffer OAS clawback since the TFSA amount is not considered taxable income.

Essentially, depending on how high your retirement income will be, generating income from a TFSA account can help you keep most or all of your government benefits.

If you expect to qualify for Guaranteed Income Supplement (GIS) benefits, a TFSA is a better option as well, since RRSP income could put you over the income threshold required to qualify for GIS.

4. When Saving for Retirement – Maybe?

RRSP accounts are designed for retirement savings, period. Not for emergency funds or to serve as your piggy bank. If you decide to start withdrawing funds early for other purposes, you will have to pay taxes immediately (via withholding taxes) and will lose that contribution room permanently.

Some exceptions to this rule are withdrawals under the Home Buyers’ and Lifelong Learning plans.

If you want a savings account you can access with some flexibility, such as for a home downpayment, wedding, vacation, etc., a TFSA is preferable.

Withdrawals can be re-contributed the following year and your contribution room is not lost. In addition, funds withdrawn are not included in your income and no tax is due.

5. When Saving for Retirement with no Income

Your total RRSP contribution room is based on your earned income from prior years. Earned income refers to income from employment, rental properties, business income, research grants, royalties, etc.

If you do not have “earned” income and want to grow your retirement pot using a tax-sheltered account, a TFSA is your only choice. You can put cash gifts, cash inheritance, and more in your TFSA.

6. If Saving While Retired

At age 71, you can no longer contribute to an RRSP. However, there is no age limit for a TFSA account. You can save any excess funds you have in a TFSA and have it grow tax-free.

7. If You Have a Group RRSP

If you are enrolled in a Group RRSP at work and your employer offers contribution-matching, it makes sense to take advantage of this ‘free’ money offer and prioritize your group RRSP contributions over the TFSA.

Check out this article for more on Group RRSPs.

Related Posts:

Conclusion

Both the RRSP and TFSA are great accounts and you should utilize them both whenever possible. If you max out your contributions to one account and still have funds to invest, put them into the other account.

You will be thankful you did when retirement comes knocking!

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Enoch Omololu

Enoch Omololu is a personal finance expert and a veterinarian. He has a master’s degree in Finance and Investment Management from the University of Aberdeen Business School (Scotland) and has completed several courses and certificates in finance, including the Canadian Securities Course. He also has an MSc. in Agricultural Economics from the University of Manitoba and a Doctor of Veterinary Medicine degree from the University of Ibadan. Enoch has a passion for helping others win with their personal finances and has been writing about money matters for over a decade. His writing has been featured or quoted in the Toronto Star, The Globe and Mail, MSN Money, Financial Post, Winnipeg Free Press, CPA Canada, Credit Canada, Wealthsimple, and many other personal finance publications.

His top investment tools include Wealthsimple and Questrade. He earns cash back on purchases using KOHO, monitors his credit score for free using Borrowell, and earns interest on savings through EQ Bank.

4 thoughts on “TFSA vs. RRSP: Which is Better For You?”

  1. Good comparison. We have 401 and IRA. Traditional IRA and 401 stack up evenly. I might consider maxing out Roth IRA before maxing out 401 (of course would get the match first).

    Reply
    • @Dividend Geek: I am not very conversant with the registered accounts in the U.S., but do know that the 401(k) is very similar to our RRSP. I assume Traditional IRA is more like a TFSA account?

      Reply
  2. Hi, I was on the Internet and stumbled upon an article about TFSA on Wealthsimple. You were quoted in that article and I was happy to see your name out there. Thanks for the information you put out weekly, it’s changed the way I manage my finances now. Looking forward to this week’s newsletter.

    Reply
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