Canada has established several financial options that make it easier and advantageous for Canadians to save. For example, we have the Tax Free Savings Account (TFSA) and the Registered Retirement Savings Plan (RRSP), both of which offer tax sheltering for savings. And, you don’t have to choose either/or. In fact, we advise our members to set up both plans as a way to achieve their financial goals.
Now – once you have both set up, and have some money to invest – how do you know which account to use?
1. You want easy access to your savings
Your TFSA is a great way to save for shorter-term goals like travel, a vehicle purchase, home renovations, or going back to school. The money you put into your TFSA is after-tax dollars and the money you earn on your investment is not taxed. The benefit of a TFSA is that you can withdraw it at any time without the worry of increasing your taxable income.
On the flip-side, if you withdraw from your RRSP prior to retiring, you’ll pay withholding tax and must report the amount as taxable income that year. (There are some exceptions – like for a first-time home purchase, or full-time study.) But there’s no penalty for withdrawing money from your TFSA, or for reinvesting what you withdrew – as long as you keep an eye on your annual contribution limit. PLUS use any carry-forward from years you did not contribute the maximum, going back to 2009. If you want a fund that can grow tax-free and keep money accessible for when you need it, TFSAs are simply more flexible.
The benefit of a TFSA is that you can withdraw it at any time without the worry of increasing your taxable income
2. You predict your income tax rate will be lower in retirement
The main difference between an RRSP and a TFSA is when you pay tax on the money you’re investing. Because you deduct RRSP contributions from your taxable income, your RRSP savings are considered pre-tax dollars. This means you will have to pay taxes when you begin to draw money from your RRSP account.
For most Canadians, their personal tax rate will be lower in retirement so it’s advantageous to claim deductions now, when their personal tax rate is higher, and withdraw the money in retirement when their personal tax rate is lower.
Here’s an example of how your taxes might break down if your yearly working salary is between $48,535 and $83,451 with a predicted lower retirement income:
| TFSA | RRSP | |
| Your pre-tax contribution | $1000 | $1000 |
| Tax you’ll pay upfront on your contribution, at 28.2% | 282 | 0 |
| Net contribution (2020) | 718 | 1000 |
| What you’ll make investing 20 years at 5.5% | 1377 | 1918 |
| Total in each plan after 20 years (2040) | 2095 | 2918 |
| Tax due when you withdraw the money, at 28.2% | 0 | 823 |
| Cash in hand in 2040 | $2095 | $2095 |
However when you combine your income in retirement from RRSPs, workplace pensions, Canada Pension Plan (CPP), Old Age Security (OAS), and Guaranteed Income Supplement (GIS) you may find that having a tax-free source of income is beneficial. No matter what your income or tax margin is, you won’t have to report TFSA withdrawals as income, or pay tax on them.
Here’s an example of how your taxes might break down if your yearly salary is between $48,535 and $83,451 with a higher a predicted higher retirement income.
| TFSA | RRSP | |
| Your pre-tax contribution | $1000 | $1000 |
| Tax you’ll pay upfront on your contribution, at 28.2% | 282 | 0 |
| Net contribution (2020) | 718 | 1000 |
| What you’ll make investing 20 years at 5.5% | 1377 | 1918 |
| Total in each plan after 20 years (2040) | 2095 | 2918 |
| Tax due when you withdraw the money, at 31% | 0 | 905 |
| Cash in hand in 2040 | $2095 | $2013 |
3. You’ve maxed out contributions to your RRSP
While RRSP and TFSA guidelines were created to encourage Canadians to save, there are significant penalties for over-contributing to these plans. RRSP contribution limits are set at 18% of your earned income annually, and you can carry forward unused contribution room. There may be years when you have more to invest than your RRSP room allows, in which case, your TFSA is a great place to invest that money. Your savings will grow, tax-free, and you’ll be able to withdraw the money, tax-free. As of 2020, you can have up to $69,500 in your TFSA.
Because you deduct RRSP contributions from your taxable income, your RRSP savings are considered pre-tax dollars.
4. You qualify for government programs that supplement your income
TFSA withdrawals won’t have an impact on your ability to qualify for government benefits you may receive. Lower-income households continue to qualify for the Canada Child Tax Benefit, Old Age Security (OAS), the Guaranteed Income Supplement (GIS), the Shelter Aid for Elderly Renters (SAFER) program, and/or BC Employment and Assistance (BCEA) – regardless of the amount drawn from TFSAs.
5. You’re celebrating your 71st birthday
You can contribute to your RRSP up to December 31st of the calendar year you turn 71. But, before the end of they year you must cash out your RRSPs, or convert them to a RRIF and start to withdraw minimum, taxable amounts. Your TFSA has no age-limit. You can continue to invest in your TFSA and withdraw from it tax-free. It’s a great savings vehicle if you’re planning on working past the age of 71, or have money from your Registered Retirement Income Fund (RRIF) – or other income – to invest in your later years.
Learn more about RRSPs and TFSAs.
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