TFSA vs. RRSP
For those that are not familiar, RRSP stands for Registered Retirement Savings Plan, and TFSA means Tax Free Savings Account. Both accounts are great for investors, and help you to save more while paying less (or no) income tax on accumulated interest.
First, some more on the TFSA. Money held within TFSA accounts help you to save without paying income tax on the interest your investments have earned.
As of the start of 2023, the total TFSA contribution room is $88,000. So if you’re just getting started, you have lots of room, and that room keeps going up each year (in 2023 it went up $6,500 from $85,500). Note that you must have been born before 1991 in order to deposit the total of $88,000. If you were born after that date then things get a little tricky, and some research on your part is probably a good idea to ensure you don’t overcontribute, if you’re in such a position (a very good position). Each year CRA will confirm how much room you have, but its always a good idea to keep track of your contributions as a cross-reference. Sometimes the numbers from CRA are not up to date. Withdrawals from a TFSA can be made at any time, just keep in mind that the amount withdrawn can not be deposited back into the account until the following year (if you’ve maxed out your contribution room).
RRSPs on the other hand help defer income tax until retirement. You do not pay income tax on the amount deposited into your RRSP; it is deferred until retirement. At age 71 you must convert your RRSP into a RRIF (Registered Retirement Income Fund), and the next year withdrawals from the account are required. There is a minimum amount per year that must be withdrawn and is a specific percentage, based on your age, of your overall investment. The money withdrawn is counted as income and is taxed accordingly. The assumption is that once you’re retired you will be earning less, thus reside in a lower tax bracket and pay less overall tax.
When deciding whether to put your money in a TFSA or RRSP, there are a lot of factors to consider. One is your current employment situation. Do you expect to be making a lot of money in the future, or are you near your highest earning years? Those are the years that you want to put the most money in your RRSP.
Another factor to consider is whether you think you may need access to the money at some point in the future, or if its more likely to be a long-term investment and won’t be touched. If you’re confident it won’t be touched, and you are in your higher income years, then an RRSP may be your best bet. RRSP contributions can also ensure you keep the money invested, as there is withholding tax for withdrawals, and that money can never be re-invested in the RRSP; you lose that ‘room’, so there is more incentive not to withdraw the money.
A TFSA is of course tax free, so that is a huge incentive. Maxing out a TFSA as soon as possible should be the goal for most young investors since they are likely yet to hit their highest income years. Interest accumulated within the account is not counted as income, and hence not taxed, so your investments grow tax free for as long as they are held in the TFSA.
Those saving for a home, who have never owned before, might lean toward contributing to their RRSP. Going this route will allow you to take advantage of the Home Buyers’ Plan (HBP), which will allow withdraws from RRSPs if they are used to buy a home. It also can be used to or build a home for yourself or a relative with a disability and withdrawn funds don’t have to be paid back for 15 years. For more information on conditions and details you can visit:
Of course withdrawals from a TFSA are always allowed, with the caveat that you cannot contribute the amount withdrawn until the following year. That is unless you have enough room below the maximum deposit limit. So savings from a TFSA can also be put towards the downpayment of a home.
A final consideration for RRSPs: if your employer offers a group savings plan where they match your contributions up to a certain amount (say 3 or 4%) then that should definitely be taken advantage of. Many employers offer savings plans like this in lieu of pensions. It is essentially free money, and can result in an even greater savings on income tax.
In summary, both RRSPs and TFSAs have advantages. There is no perfect recipe, and its impossible to predict what the future will hold, but with a little homework and some careful consideration, most people can determine the best route for their own specific situation.
