RRSP vs. TFSA – what’s better for me to invest in?

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Time to read: 4 minutes

RRSPs and TFSAs are both great options for saving money on your taxes. Here’s a quick primer on the differences between the two.

TFSA:

  • Any investment income you earn in a TFSA (like interest, dividends and capital gains) won’t be subject to tax. It’s really flexible; you can contribute and withdraw amounts whenever you want.

  • There’s a limit on how much you can contribute to a TFSA, which is increased each year. In addition, any amount you withdraw from your TFSA gets added to your contribution room the following year. (That means if you withdraw $5,000 in 2020, then $5,000 will be added to your contribution room for 2021.)

  • To check your contribution limit, visit the CRA’s My Account.

 

RRSP:

  • When you contribute to your RRSP, you can claim a deduction on your tax return. For example, if you contribute $5,000 to your RRSP, you can reduce your taxable income by $5,000.

  • Once you contribute to your RRSP, the funds grow tax-free until you withdraw it. Once you withdraw the funds, you’ll be taxed on the amount you withdraw. It essentially gets added to your taxable income for the year, along with any other income like employment income or self-employment income.

  • The idea is that you contribute to your RRSP when you’re working and in a higher taxer tax bracket, let the funds grow tax-free, and then withdraw the amounts in retirement when you’re in a lower tax bracket. That way you get the contribution deduction when you’re in a high tax bracket, and get taxed on it when you’re in a lower bracket.

  • You can also “borrow” from your RRSP to pay for your first home or to pay for your education if you’re currently in post-secondary school. If you don’t repay these amounts to your RRSP, then it will be added to your income.

  • You can contribute to your RRSP whenever you want, but there are deadlines if you want to claim it on a certain tax return. For example, if you contribute to your RRSP by March 1, 2021, then you can claim that deduction on your 2020 tax return. Otherwise, you’ll have to claim it on your 2021 tax return.

  • You accumulate RRSP contribution room by having earned income (like employment or self-employment income). The limit for 2020 is 18% of your 2019 earned income, up to $26,500.

Deciding between TFSAs and RRSPs

  • This is an area that depends on your specific situation and different assumptions, so we recommend speaking with a financial planner to come up with a strategy for yourself.

  • In general, TFSAs are better in these situations:

    • You’re currently in a low tax bracket (making less than $50,000).

    • You expect to be in a higher tax bracket when you withdraw the funds.

    • You’re saving for a short-term goal and you want the flexibility to withdraw and recontribute whenever you want.

  • In general, RRSPs are better in these situations:

    • You’re currently in a high tax bracket (the highest bracket is for those earning more than $215,000).

    • You expect to be in a lower tax bracket when you withdraw the funds.

    • You don’t plan on using the funds until retirement, or you’ll be using the First-Time Home Buyers’ Plan or the Lifelong Learning Plan.