Which is better? RRSPs vs TFSAs
RRSPs and TFSAs are the two preferred accounts for savers in Canada, but each has its advantages, contribution limits and tax treatment.
Wondering which investment to choose in which situation? You've come to the right place!
The guide below tells you everything you need to know about TFSAs vs RRSPs, how they differ and how each account is taxed.
What are TFSAs and RRSPs?
Before comparing the two types of accounts, it is helpful to review what they are and how they work:
How does a TFSA work?
A tax-free savings account (TFSA) is a registered account that works by allowing Canadians to set money aside and invest it, tax-free, for the future. Restrictions apply to the TFSA such as the annual and total amounts of contributions allowed, but once your money is in the TFSA it can be invested into numerous assets, including stocks, bonds, ETFs, GICs and mutual funds.
Since any investments held within a TFSA are tax-exempt, if your investments grow, then the earnings from these investments are completely tax-free; including interest, dividends and capital gains. Meaning, that when you need or want to withdraw money from your TFSA, you can do so without having to report the gains during tax season.
How does an RRSP work?
A registered retirement savings plan (RRSP) works differently from the TFSA outlined above since contributions to the RRSP can be claimed as a deduction against a household's annual income tax bill. This effectively lowers an individual’s income tax and maximizes the amount they can invest toward their future.
Any money within an RRSP can be invested into approved assets such as GICs, equities, bonds, mortgage loans, ETFs, mutual funds, income loans and savings accounts. As the RRSP is financially incentivized, any growth is tax-free while it remains within the account.
Since the RRSP is a specific retirement savings plan, it does come with a few restrictions. Most notably, any contributions and subsequent interest on investments can only be withdrawn tax-free on two occasions: through either a Home Buyers Plan (HPB) or Lifetime Learning Plan (LLP). Any other withdrawals from the RRSP have to be declared as income and will be subject to the individual’s income tax rate.
What is the difference between an RRSP and a TFSA?
While both are registered accounts with financial incentives, there are very important differences between RRSPs and TFSAs. Mainly, RRSPs are specifically designed for your future and retirement, while the TFSA is more of a supplementary savings account to the RRSP. The other differences to know when comparing TFSAs vs RRSPs are:
|What was the initial purpose of the accounts?||The TFSA was introduced to help Canadians meet savings goals by allowing savings to grow tax-free.||RRSPs were introduced to prompt savings for retirement.|
|When were the RRSP and TFSA accounts introduced?||2009||1957|
|Are there limits on annual contributions?||Yes, the TFSA annual contribution limit is currently $6,000.||Yes, the RRSP contribution limit is 18% of your reported earned income and a maximum of $29,210.|
|What happens to unused contributions?||Unused TFSA contributions can be carried forward.||Unused RRSP contributions can be carried forward.|
|Is there a maximum contribution age?||TFSAs do not have a maximum contribution age.||Contributions to RRSP accounts can only be made up to the age of 71.|
|How do the tax advantages differ between RRSPs and TFSAs?||TFSAs offer tax-free growth and tax-exempt withdrawals.||RRSPs offer upfront tax deductions on contributions and tax-free growth.|
|RRSP and TFSA withdrawal rules.||TFSA accounts have lifetime tax-free withdrawals||Money in RRSP accounts can be withdrawn but will be subject to your annual income tax except for Home Buyers Plan (HBP) or Lifetime Learning Plan (LLP) withdrawals.|
The funds must be withdrawn or converted to an RRIF or annuity by age 71.
|Can you contribute to a spouse’s RRSP or TFSA||[No]||Yes and you will also receive the tax deduction benefit|
If you already know which account is best for you, you can speak with a financial advisor now to start investing.
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Should I invest in a TFSA or an RRSP first?
Deciding on whether to invest in a TFSA or RRSP first can be a difficult decision which is often determined by an individual’s financial situation and goals. However, certain guidelines can be used in helping you decide if you should favour a TFSA over an RRSP.
Highlighted below are numerous situations which should be considered when deciding between investing in an RRSP vs TFSA.
Employer RRSP Matching Contributions
Group retirement savings plans, or GRSPs, are set up by employers and offer the same financial incentives as RRSPs. However, some employers opt to include a matching program within the group RRSP and will often contribute anywhere between 2% - 5% of an employee’s pre-tax salary to the RRSP, in addition to any contributions the employee makes themselves.
While both contributions count toward the annual RRSP contribution limit, the money from the employer RRSP matching program is essentially free money. For example, a 3% employer match scheme on a $60,000 annual salary would result in an additional $1,800 in your RRSP.
Good to know
If you are fortunate enough to receive an employer match in a group RRSP, investing in the RRSP before the TFSA would most likely be the best option.
Federal Tax Brackets
Your federal tax bracket is determined by your annual income. The more money you earn in any given year increases the amount of tax you owe. The Canadian federal tax brackets in 2022 break down like this.
|20.5%||$50,197 up to $100,392|
|26%||$100,392 up to $155,625|
|29%||$155,625 up to $221,708|
As we know, RRSP contributions reduce your taxable income. The more you contribute to your RRSP, the more money you’ll get back on tax deductions. But how does this relate to whether you should invest in an RRSP or TFSA first?
Not considering provincial taxes, if an individual has an annual income of $40,000 they will be paying 15% in tax. For every $1,000 contributed to an RRSP, this person will receive $150 in a tax refund. On the other hand, an individual who has an annual income of $120,000 will receive a tax refund of $260 for every $1,000 contributed to their RRSP.
With the above in consideration, anyone who earns over $50,197 should consider investing in an RRSP before a TFSA as it can make more sense financially. The optimal goal is to contribute enough to the RRSP to lower your taxable income to a lower tax rate.
Good to know
If you earn over $50,197 consider investing in your RRSP before your TFSA. This may help you lower your taxable income and save on taxes.
Investment Time Horizon
The investment time horizon is the amount of time you expect to let your investments grow. A long time horizon is usually considered as your retirement, whereas short and intermediate time horizons are for anything less.
Your specific investment time horizon will determine whether or not you should invest in an RRSP vs a TFSA, and fortunately, the type of account you should choose is in the name. If your investment goal is to have as much money as possible for your retirement, then you should invest in a registered retirement savings plan, RRSP, before TFSA.
For short and medium-term time horizons a TFSA would suit your investment needs better. One main reason is that any money that you withdraw from the TFSA is tax-exempt, as covered earlier.
Purpose of investments
The aforementioned investment time horizon goes hand in hand with the purpose of your investment. It is easy to say that the RRSP is solely for retirement purposes while the TFSA is more suitable for shorter-term investment goals. However, there are a few notable exceptions to the rule.
- Home Buyers Plan (HPB)
- Lifetime Learning Plan (LLP)
If one of your goals is to buy or build a home and/or go back to full-time education or training, you might think these goals fall under the short to intermediate investment time horizons. And you would be right.
For these investment goals, however, an RRSP is likely more suitable than a TFSA since both the Home Buyers’ Plan (HBP) and Lifetime Learning Plan (LLP) allow you to borrow money from your RRSP tax-free. Thus, giving you the benefit of the annual tax reduction for contributions as well as tax-exempt withdrawal.
Do you still need some help picking between an RRSP and a TFSA? A finance expert can help get you squared away.
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Can I transfer from an RRSP to a TFSA?
Yes, you are able to convert your RRSP into a TFSA although a withholding tax will be applicable to any money withdrawn from the RRSP. Despite the withholding tax and having to report the withdrawal as income on your tax return, if your income is low enough then you may get a tax refund which offsets the withholding tax.
RRSP and TFSA Tips
There are plenty of RRSP and TFSA tips ranging from when to favour one over the other or how to spread your contributions between both. To save you time and effort, we’ve compiled the best RRSP and TFSA tips below so you can easily see how to maximize the use of both accounts.
How to take the best advantage of the RRSP
- If your employer offers an RRSP matching scheme or group RRSP, take advantage of every penny of the matched contribution. Their match is essentially free money.
- Utilize the tax deduction to the utmost in order to lower your overall taxable income to a lower tax bracket.
- Invest in the RRSP from an early stage to gain the most from compound interest.
- Invest your RRSP contributions into low-cost equities and/or bonds through ETFs.
- Use the RRSP to save for building or buying a home and education through the HBP and LLP incentives.
How to take the best advantage of a TFSA
- Contribute early and contribute often to maximize the compound growth of your investments.
- Since TFSAs commonly offer better interest rates than savings accounts, keep your emergency fund uninvested in your TFSA to get the highest growth possible and to maintain tax-free access to your cash.
- If you come into unexpected money, maximize your contributions to the TFSA by taking advantage of any unused contribution allowance from previous years.
- Invest any money outside of your emergency fund into low-cost, highly diversified investments such as ETFs.
Good to know
Remember, there is no rule that says that you have to choose an RRSP account over a TFSA, or vice versa. A perfectly good RRSP and TFSA strategy is to utilize both accounts to maximize your tax-free investment growth.
How do you invest after you maxed out both your RRSP and TFSA?
If you’ve maxed out your contribution allowances for both your RRSP and TFSA, it is important that you do not continue contributing to either. Over-contributing to either your RRSP or TFSA will result in tax penalties of 1% per month, which can quickly add up. It is therefore vital to look into other investment options once you have maxed out your TFSA and RRSP.
Below you can find a few tips on how to continue investing and take the best advantage of registered and non-registered accounts.
Investing in registered accounts:
- TFSA or RRSP: If you have a spouse or adult children, you can help them contribute towards their own RRSP or TFSAs in order to get their investment journey started.
- RESP: The Registered Education Savings Plans can be used to save for Some of these contributions are eligible for certain government grants and bonds such as the 20% Canada Education Savings Grants.
- RDSP: Registered Disability Savings Plans are savings vehicles that help parents secure the long-term financial future of anyone eligible for the disability tax credit (DTC). These accounts also offer tax-free withdrawals and Canada Disability Savings Grants and Bonds
- VRSP: Voluntary Retirement Savings Plans are Quebec-only savings and investment plans that are offered by employers to help employees save for retirement. Any contributions are deducted directly from payroll which decreases your taxable income.
Investing through non-registered accounts and alternative investment methods.
- Online brokerages: Online brokerages allow investors to tap into multiple stock exchanges and asset classes. Online brokerages allow investment in equities, bonds, cryptocurrencies, commodities and ETFs or Mutual Funds.
- Robo-advisors: Robo-advisors are automated financial advisors that automatically invest your money based on certain criteria such as risk profile. They are perfect for individuals who do not have the time or interest to manage their own investments.
- Financial Advisors: Financial advisors are ideal for the investor that wants a personal touch or who wants to invest in more unusual investment opportunities. Often, a financial advisor will help you manage your overall personal finances as well as handle the management of your portfolio.
Real Estate: Real estate investments usually require a significant amount of time and capital to get started. It is high risk but can yield high profits. Those who want to avoid investing directly in brick and mortar but still wish to invest in real estate can do so through Real-Estate Investment Trusts (REITs) or industry-relevant ETFs.