Registered Retirement Savings Plans (RRSPs) and Tax-Free Savings Accounts (TFSA’s) are both vehicles for investment and both of these vehicles contain a tax-free component within them. Before deciding which, if either – or both – are worthy of receiving some funds, it’s important to know the similarities and differences between the two, and then compare that to your own unique situation before making a decision.

Tax-Free vs. Tax-Deferred

TFSA’s are tax-free, which means that as you contribute to your TFSA, you can contribute up to the maximum contribution room limit and not one cent over the maximum limit.   If you accidentally over-contribute to your TFSA, there are penalties, and if you take out money from your TFSA, you can put in more money at any time up to the TFSA ceiling.  If, and when, you decide to withdraw funds from your TFSA, there are no tax implications for doing that.

Contributions to your RRSP, however, are tax-deferred, which means that not only do you pay tax on any funds that you withdraw (take out) from your retirement savings but if you withdraw funds before you reach the age of 71-years-old, you do not, in most cases, have the opportunity to put funds back into the account because you lose that space.

The intention of the RRSP is that it provides an opportunity for Canadians to save for their retirement, by putting away money when then are presumably at a higher income level than when they withdraw the funds at age 71. You can use your RRSPs to pay for your first home (Home Buyer Plan) or for your education (Lifelong Learning Plan). These plans are not available with the TFSA.

When contributing to an RRSP, the government provides the account holder with a tax deduction which reduces taxes owing/increases refunds, so not only are Canadians putting away money for retirement but they also get a tax reduction as a result.

If you plan on withdrawing some or all of your investment before retirement, then TFSA’s might be the better option for you.

What’s the Maximum Amount You Can Contribute to Your TFSA?

TFSA’s were first introduced in 2009 and many if not most Canadian financial institutions now offer them. A TFSA allows any Canadian over the age of 18 to save or invest money in a tax-free account. Essentially the “tax-free” part means that you don’t pay taxes on the money you make within your TFSA. That means things like interest payments, stock dividends, or capital gains.

However, like everything good in life, there are limits.  With TFSAs there’s a maximum amount of money you can deposit each year. Luckily, your total contribution is cumulative, so you can rollover this contribution room year-to-year which means the amount you can save will go up each year, whether you deposit money or not. Visit the CRA website to review the TFSA contribution room.

There is a difference between your TFSA contribution room, and the maximum TFSA contribution allowed during the taxation year.

For example;

Joshua registered for the TFSA when he turned 21 years old in 2020. Although the TFSA was available since 2009, he can only carry forward the contribution room since he turned 18 which was in 2017.

His total contribution room is $5,500(2017) + $5,500 (2018) + $6,000 (2019) + $6,000 (2020) which is a total of $23,000. Joshua can contribute the whole amount of $23,000 in 2020 or less. When and how much can Joshua withdraw any funds?

  • If Joshua contributes the full amount of $23,000 in 2020 (either as a lump sum or periodic contributions), he will not be able to contribute anymore until the next year. He can withdraw the full fund at any time tax-free.
  • If Joshua contributes $3000 in January 2020:
    • He can contribute more until he maximizes his contribution room as long as he doesn’t withdraw any funds.
    • However, if at any point he decides to withdraw money from the TFSA, he will not be able to contribute more than the maximum allowed contribution of the taxation year even if he has more contribution room.
    • So if he contributes a total of $3000 in 2020, then withdraws $1000 in the same year, he will not be able to contribute more than $3000 in 2020 (remainder of $6,000 yearly limit: $6000 – $3000 = $3000) until the following year.

Other RRSP Income Tax Deductions

On the off chance that you have not maxed out your contributions to your RRSP, you can also make contributions to your spouse’s RRSP, and those contributions are tax deductible on your tax return.  While the deduction does not translate to an income tax refund on its own, it can help to lower your tax payable. Contributions come off your gross income dollar for dollar, dropping your taxable income which is the amount you pay tax upon.

Spousal RRSP’s are a great way to further reduce the amount of taxes payable upon retirement, especially in the case where one spouse or common-law partner is a much higher income earner, because, upon retirement, the total amount of the RRSP’s would be a bit more even, meaning potential lower tax rates for the highest income earner.

TSFA contributions, on the other hand, yield no tax deduction on your annual tax return.

Canadians looking for the added benefit of a tax deduction might find RRSP’s a more suitable investment vehicle for you.

Additional Options

RRSP’s have a few extra features which might appeal to you and help sway your decision as to which investment vehicle to use.   Funds contributed to RRSP’s can be withdrawn in two special situations without penalty – the Home Buyer’s Plan and the Lifelong Learning Plan. Both of these plans allow you to withdraw funds from your contributions and repay the amounts over time.  If you’re looking to purchase your first home, you can withdraw up to $35,000 from your qualifying RRSP contributions without penalty and then repay the withdrawal back into your RRSP account over 15 years. Similarly, the Lifelong Learning Plan allows taxpayers to withdraw up to $10,000/year up to $20,000 in total to pursue full-time training or education for you or your spouse. The designated repayment period for an LLP is ten years.

TFSA’s do not have extra options.  It’s as simple as contributing and withdrawing within the limits.

If you’re unsure about which savings plan is best for you, think about why you’re saving.  Are you putting money into an RRSP in order to reduce your taxes owing and put away money for retirement, or are you saving money to purchase something like a cottage or a boat?  Maybe your intention is to go back to school or purchase your first home, or maybe you just don’t know if you’ll need the money and want the tax benefits.  In the above examples, the option of RRSP, TFSA, or both should be considered, reviewed, and weigh the pros and cons of every option.

How to choose between plans

TFSA’s can also be better options when:

You’re a senior:

  • There are no age limits on contributions.
  • You don’t have to make withdrawals, unlike RRSP’s where you have to start making withdrawals when you are 71.
  • Contributing to or withdrawing funds from an RRSP/RRIF may cause some of your retirement benefits, such as your Guaranteed Income Supplement (GIS) or your Old Age Security (OAS), to be clawed back.

You are young:

  • If you’re expecting to increase your earnings over the next few years, which will move you to a higher tax bracket, you could use a TFSA to “hold” your savings now and then transfer them to an RRSP later, giving you a bigger tax break on your income tax.

You are saving for reasons other than retirement:

  • The best thing to do with the money you put into a TFSA account is, of course, to leave it there, so the money gets a chance to grow. But everyone should have some kind of emergency fund, too, and many RRSP fund choices lock the money in for a certain period of time, making a TFSA a better choice for the money you might have to access on short notice.

 

An RRSP is the Best Choice for Some

Putting your money into an RRSP instead of a TFSA would be the best choice for people with a reasonable working income (over $37,000 a year) and modest retirement savings or pension, and for people with a high working income, which generally exceeds $120,000 per year.  Modest retirement savings are considered between $250,000 to $750,000 when you will retire.

The RRSP is also the best choice for people who have trouble leaving their savings alone, as generally it’s more difficult to take money out of an RRSP than out of a TFSA, and it is also very costly to do so – there are penalties to withdraw money from RRSPs.