TFSA vs RRSP: How to Choose?

TFSA vs RRSP

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What is TFSA, RRSP and how do they differ? Find answers to this and many more questions on this comprehensive TFSA vs RRSP guide.

The question on which is better between TFSA vs RRSP is often asked by “newbie” investors who want to make the most of their money (or savings).

Unfortunately, most of what is available out there as answers to this question are not clear enough to help make the best decision. The truth is, against most of the information available out there, both TFSA and RRSP share some common similarities and differences.

Therefore, a critical comparison of TFSA vs RRSP must consider both their similarities and differences.

Consequently, I decided to fill in the gap by writing this comprehensive TFSA vs RRSP guide.

At the end of this guide, you should be able to know which is right for you.

TFSA vs RRSP: Comparing Key Accounts Features?

  • Primary Use – Registered Retirement Savings Accounts (RRSPs) are typically used to save for retirement. TFSAs are typically used to save for any purpose such as investment, mortgages, or any other purpose.
  • Eligibility – You must be the age of majority in your province or territory of residence to open a TFSA account in any bank. You cannot start to contribute to your RRSP until you start earning employment income.
  • Contribution Limit – The 2019 and 2020 contribution limit for a TFSA is $6,000. The 2020 RRSP contribution limit, on the other hand, is 18% of earned income reported on your 2019 tax return or $27,230 – whichever is lower.
  • Unused Contribution Room – Your unused contribution room is carried forward for both RRSPs & TFSAs.
  • Withdrawals – RRSP withdrawals are taxable. TFSA withdrawals are tax-free.
  • Withdrawn Amounts – When withdrawing funds from an RRSP, the contribution room is lost for amounts withdrawn. For a TFSA, withdrawn amounts are added back to the contribution room in the following year.
  • Taxation – TFSA contributions are not tax-deductible. RRSP contributions are tax-deductible.
  • Plan Maturity – No age limit for TFSA. An RRSP matures at the end of the calendar year in which you turn 71 years of age.
  • Spousal Plan – While there is nothing like a spousal TFSA, you can contribute directly to your spousal RRSP.
Feature  TFSA RRSP
Primary Use For any purpose For retirement savings.
Contribution Limit

 

 

Varies per year. (Maximum of $6,000 for 2021) 18% of the previous year’s earned income or the contribution limit of $27,830 (as of 2021)

 

Withdrawals Tax-free Taxable (with exceptions)
Expiration No Yes (when you turn 71, you must convert it to a Registered Retirement Income Fund (RRIF)
Spousal Plan No Yes

What is a Tax-Free Savings Account (TFSA)?

A TFSA is a kind of special account in Canada that allows you to save or invest your money without being subject to ‌any‌ ‌tax‌ ‌deduction. Accordingly, you are not charged any tax on your savings or investment income, such as capital gains and dividends.

In addition, a TFSA doesn’t impose taxes on administrative, interest or debt that are related to your TFSA account.

TFSA is designed for multi-purpose investing. Unlike regular accounts that are devoted to particular uses, you can use TFSA however you like.

Consequently, you can use TFSA to invest in stocks, bonds, GICS, or mutual funds.

TFSA has grown in popularity in Canada since its launching in 2009. It’s obvious to see why. This account provides a competitive return over regular savings accounts, making it ideal for leveraging tax benefits.

What are the Advantages of TFSA?

  • Tax-free savings over time.
  • No minimum income requirements.
  • Easy withdrawals.
  • Emergency fund.
  • Maximizes retirement savings.
  • No expiry date.

What are the Disadvantages of TFSA?

  • Strict penalties for over-contribution (1% monthly interest).
  • No tax refund.
  • Annual contribution limit.
  • No spousal plan.

To learn more about TFSA, click here.

What is a Registered Retirement Savings Plan (RRSP)?

An RRSP was introduced in 1956 to help Canadians prepare for retirement. This account doesn’t also impose taxes on contributions and earnings such as interest or capital gains.

Like TFSA, you can use RRSP to invest in different investment vehicles such as stocks, bonds, mutual funds, GICs etc. However, unlike TFSA that has no expiry date, you are expected to convert your RRSP to RRIF by December 31 of the year you reach the age of 71.

What are the Advantages of RRSP?

  • Spousal plan.
  • Investment-friendly.
  • Tax-free contribution.
  • Tax refund.

What are the Disadvantages of RRSP?

  • Expiry date.
  • Withdrawal tax charges
  • Strict withdrawal rules
  • Permanent loss of RRSP contribution room

To learn more about RRSPs, click here.

RRSP vs TFSA Contribution Rooms

In this part of my TFSA vs RRSP guide, I present the different contribution rooms of TFSA vs RRSP.

Registered Retirement Savings Plan Contribution Room

RRSP contribution room, also known as deduction limit or contribution limit, refers to the maximum annual amount you can contribute to your RRSP tax-free.

The‌ ‌Canada Revenue Agency (CRA) sets the RRSP contribution room every year.  For 2021, the contribution limit was increased to $27,830 for 2021. However, for those with 18% pre-tax income that exceeds the contribution limit of the current year, the annual contribution limit is their contribution room.

Therefore, by increasing your income growth and carrying forward your unused contribution limit, you increase your contribution room annually.

RRSP Deadline 2021

RRSP contribution deadline varies year by year. But the deadline to make 2020 RRSP contributions is March 1, 2021.

By failing to meet the deadline for RRSP contribution, you’ll miss a tax break and tax-free investment growth.

Consequently, you can’t make any contribution to your RRSP account within the year again.

However, all hope is not lost. Your unused contribution room can be carried forward to the following year.

RRSP Withdrawal Rules

Unlike TFSA, RRSP has two major withdrawal rules. These are:

  1. Taxes apply when you make withdrawals prior to reaching the age of 71. However, there are no tax charges when you make a withdrawal for the purpose of funding the Lifelong Learning Plan (LLP) or the Home Buyers’ Plan (HBP).
  2. When you make RRSP early withdrawals you miss your contribution room forever.

TFSA Contribution Room

Just like RRSP, TFSA contribution room refers to the number of funds you can deposit to your TFSA account annually.

Your current TFSA contribution room is determined by your unused contribution room and current annual contribution room.

Therefore, if you have not used TFSA since its launch in 2009, you have a big contribution room.

This is because your cumulative contribution room will be calculated from 2009 to date (which amounts to $75,500 in 2021).

Just like RRSP, your unused TFSA contribution room is rolled over to the next year.

In 2021, the contribution limit for TFSAs is $6,000. This is the same with the contribution room of  2019 and 2020.

However, over-contributing to a TFSA is not permitted. This refers to contributions that exceed your maximum contribution room.

Over-contributions are penalized by the Canada Revenue Agency (CRA) at 1% a month, but not until the excess contribution is withdrawn.

As a result, it is important to confirm how much TFSA contribution room you have by checking your CRA MyAccount or using a TFSA calculator.

Is There a Deadline to Contribute to TFSA?

Unlike RRSP, TFSAs contributions are not subject to a deadline. Also, any unused contributions are carried forward to the next year.

Consequently, you can make your TFSA contribution at any time.

Now that you have a clear picture of what TFSA and RRSP entail let’s move to the major part of this guide.

TFSA vs RRSP: Similarities and  Differences

As mentioned earlier, most of the comparisons out there about TFSA vs RRSP only focus on the differences without acknowledging their common grounds.

The truth is, for a better understanding of these great accounts, it’s important to look at the two sides of the coin.

Comparably speaking, the major similarity between TFSA and RRSP is their tax-saving features.

Contributions into the TFSA are not tax-deductible and cannot be used to reduce the tax burden.

However, growth and gains on TFSA investments are tax-free or tax-exempt and can be withdrawn at any time.

On the other hand, contributions to RRSP are tax-deductible in the sense that they can be used to reduce your tax burden.

But in this case, growth and capital gains are tax-deferred in the sense that you won’t be taxed if the growth is not withdrawn. But upon withdrawal, the income will be taxed.

One of the major advantages of using a TFSA is that you can use it as a vehicle for your emergency fund.

However, you can’t do that for RRSP because of withholding taxes and the loss of contribution room

RRSP vs TFSA Tax Protection Works on the Principle of Now vs Later.

Reduce your tax burden now by contributing to RRSP, but then you pay your taxes later upon withdrawal.

In other words, you can pay your taxes now, and use your post-tax income to invest in your TFSA to enjoy tax-free income in the future.

TFSA vs RRSP are the perfect ying and yang of the registered accounts in Canada.

Also, both TFSA and RRSP can be used as savings and investment accounts.

However, there’s no denying the fact that TFSA vs RRSP has many differences.

As discussed earlier, A Registered Retirement Savings Plan (RRSP) is a retirement-friendly account for Canadians.

On the other hand, a Tax-Free Savings Account (TFSA) is an account that is friendly for savings and any investment, including retirement.

Additionally, contributions and withdrawals on TFSA are not taxed. The opposite is the case with an RRSP account.

Also, with a TFSA account, you can access your money at any time without any penalties.

However, an RRSP account has strict withdrawal rules. Withdrawal taxes apply unless you use the fund to make a first-time home purchase through the Home Buyers’ Plan (HBP).

Unlike RRSP, TFSA doesn’t have a contribution deadline. You can make contributions anytime you like.

Finally, another difference between TFSA vs RRSP is that TFSA doesn’t have an expiry date. In contrast, RRSP expires once you attain the age of 71.

Saving for Retirement: RRSP vs TFSA Compared

If you want to save more for your retirement, consider opening an RRSP account.

This account allows you to delay paying taxes right from the time you’re young until retirement.

However, you may need to open a TFSA account to gain a tax advantage on your emergency savings.

So after you have maxed out your RRSP contribution limit, you can open a TFSA account to complement your RRSP savings.

Here are two scenarios that explained the importance of saving both on RRSP and TFSA accounts:

1. RRSP Savings

Jude is a medical doctor, ages 35. Jude is currently under a higher tax bracket, but he expects to fall under the low tax bracket during his retirement.

As a result, Jude considers RRSP the best account since it will defer his taxes until when his tax rate will be lower.

2. TFSA

Jane is an accountant, aged 35. Jane is currently under the middle-income bracket and is looking to save for emergencies.

As a result, Jane opens a TFSA account since it’s flexible and allows her to make withdrawals at any time.

Furthermore, a TFSA account will allow Jane to supplement her RRSP savings to have enough funds for her retirement.

Saving for a Home Down Payment: RRSP vs TFSA Compared

If you are saving to buy a new home, you may want to consider opening an RRSP account or a TFSA account.

RRSP Home Buyers’ Plan (HBP) allows you to make tax-free withdrawals on your account up to $35,000.

However, you’re expected to refund the withdrawn amount within 15 years.

Here are two scenarios that explained the importance of saving both on RRSP and TFSA accounts for your home down payment.

1. Saving for a Home Down Payment through RRSP

Mark is a banker aged 33 and is looking for the best account to save for his down payment alongside his retirement.

As a result, Mark opens an RRSP to save for his retirement while getting up to a $35,000 tax-free down payment.

Furthermore, an RRSP is also proper for Mark because it will help him commit to his retirement savings since early withdrawals attract penalties.

2. Saving for a Home Down Payment through TFSA

Paul is a mechanical engineer, aged 35. Paul wants to save for emergencies, down payments and retirement. However, he’s under the mid-income bracket.

As a result, Paul opens a TFSA account since it allows him to make a withdrawal at any time without losing his contribution room.

TFSA vs RRSP: Which is Better?

Now that you have a clear picture of the similarities and differences between TFSA vs RRSP, which is your choice?

Don’t make the mistake I made in rushing to decide between TFSA vs RRSP without reading all the lines.

The truth is, RRSP vs TFSA are all great but not suitable for everybody. I wish I knew this years ago!

So, to determine which account is perfect for you, consider the following three factors:

1. Your Savings Goal

If‌ ‌you’re‌ ‌planning for retirement, then an RRSP could be your ideal option.

With an RRSP, you can defer paying taxes right from your young age to retirement, when your tax obligations might‌ ‌be‌ ‌lower.

However, TFSA is not specifically built for retirement savings, but it could complement your retirement savings due to its flexibility.

Therefore, it is wise to consider a TFSA when you have maxed out your RRSP contributions to benefit from tax-free growth and withdrawals.

2. Your Income Tax Bracket

If you have a high income, you are likely to have a high tax bracket, while if you have a low income, you may have a lower tax bracket.

Consequently, you might want to consider putting funds into a TFSA if you fall under a low tax bracket to build up your capital.

Once you reach a higher income bracket, you can safely transfer your TFSA funds to an RRSP to reduce‌ ‌your‌ ‌income‌ ‌taxes.

In summary, if you have a low income, you can go for TFSA. But if you have a high income, RRSP might be the perfect choice.

3. Your Time Horizon

TFSA vs RRSP differ through investment timeframe.

Since RRSPs are primary for retirement savings, they are more suitable for long-term savings or investments.

On the other hand, TFSAs are more suitable for short and medium-term savings investments due to their flexibility.

The process of saving for retirement usually takes longer than saving for your child’s education or remodelling your house.

RRSPs are designated for retirement. Notably, it works perfectly for this very purpose.

Also, TFSA got you covered if you need money to fund emergency expenses anytime.

How to Invest Your TFSA or RRSP?

The truth is, there are many ways you can invest in TFSA vs RRSP in Canada.

However, I often recommend using Robo-advisors since they are cost-effective means of growing your portfolio out there.

Basically, when using a Robo-advisor, they will ask you a series of questions regarding your investment objective and risk tolerance so as to recommend a  ‌portfolio‌ ‌that‌ fits you. ‌

Thereafter, you will fund your portfolio and live the Robo-advisor to handle the rest.

You don’t have to worry about managing or rebalancing your portfolio yourself. All will be handle by the Robo-advisor.

Interestingly, all of this will not cost you much compared to the charges of mutual funds and financial advisors.

So how do you get started? All you need is to open an account with one of the best Robo-advisors in Canada.

Here are some of the best Robo-advisor advisors in Canada:

Robo Advisor Unique For
Wealthsimple All-round perks and low fees
Questrade Competitive offerings
CI Direct Investing Private Investment Portfolios
RBC InvestEase Big Banks
Just Wealth RESPs and Group RRSP & TFSA

 

Wealthsimple is a leading Robo-advisor packed with all the savings and investment services you need at low fees.

However, if you are looking for a Wealthsimple alternative, that should be no other than Questrade.

Questrade is no doubt next to Wealthsimple both in fees and range of financial products.

Check out my Questrade’s Questwealth Portfolios review here before making a final decision.

Verdict on RRSP vs TFSA

As you can see, both RRSP vs TFSA (or TFSA vs RRSP, still the same) are great savings and investment vehicles with tax advantages.

However, depending on your goals, income bracket, and time horizon, one may be suitable than the other.

TFSAs are flexible compared to RRSPs as you can use them to achieve short or medium-term goals.

On the other hand, RRSPs are strictly long-term vehicles that maximize your retirement savings tax-free over time.

You can probably save more through RRSP, but strict rules are attached, especially on making withdrawals.

However, if possible, you should have both an RRSP and a TFSA account in order to enjoy the benefits of the two accounts and complements their shortcomings.

In conclusion, you’re in the right position to determine which account fits your situation and whether you can have both accounts or not.

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