Families, RRSP

What’s Best? TFSA, RRSP, Both or Neither?

You have $2,500 that you are able to set aside as savings. The Tax Free Savings Account (TFSA) and the Registered Retirement Savings Plan (RRSP) are both tax-free savings vehicles, but is it better to put your money into one or the other?

The answer depends on your unique personal situation.

The first point to grasp is that while TFSAs and RRSPs are both tax-free when the money is in the account, the money you take out of the account is treated differently tax-wise. True, the money you put into either plan is allowed to grow tax-free while it’s in there, but when the time comes and you withdraw money from an RRSP, that money is taxed.

So generally, if the marginal tax rate when you are putting away the money is lower than it will be when you are retired and taking money out of the plan, then contributing to a TFSA makes the most sense because of the tax you would be paying on withdrawals from an RRSP.

However, if the marginal tax rate when you are putting away the money is higher than it will be when you’re retired, then the RRSP is the winner.

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 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 RRSP’s.

The Bottom Line

You have to do what is best for you, and there are plenty of opinions out there which may lead you to a RRSP, to a TFSA, to both or to neither.  If you are comfortable making this decision on your own, then hopefully this article helped answer some questions.