TFSA vs RRSP: How to decide between the two

Watch: The differences between a TFSA and RRSP

What is a TFSA?

A TFSA (or tax-free savings account) is a registered investment savings account that any Canadian resident, aged 18 or older, can use for straightforward savings or to hold investments. It can store things like exchange-traded funds (ETFs), guaranteed investment certificates (GICs), bonds, stocks and cash.

Any income earned in the account—even when it is withdrawn—is tax-free. This means any interest, stock dividends and capital gains earned in your TFSA aren’t subject to income tax. However, your TFSA contributions won’t reduce your taxable income like RRSP contributions will.

There’s a limit on the amount of money you can contribute to your TFSA is annually. However, you can carry forward the unused contribution room to a current lifetime maximum amount. Each year, you get an allotment of around $6,000 available for your TFSA, which means that you can put that amount away, plus any rollover from previous years (to find out how much room you have left, use this contribution room calculator).

So how is a TFSA tax-free? The money you put into this account has already been taxed—you contribute to a TFSA from your net income—so there’s no tax break at the time of contribution. But, any gains you earn in a TFSA—whether it’s from a savings account, a high-growth index fund or another investment product—aren’t subject to capital gains tax, so you won’t owe any tax on your earnings when you make a withdrawal. Plus, any gains you earn on those investments will not affect your contribution room for the current year or years to come, either. Essentially, you don’t pay tax on the money you make in your TFSA.

What is an RRSP?

A registered retirement savings plan, or RRSP, works similar to a TFSA, in that it can hold savings and investments. A significant perk of this account is that it allows you to contribute a large amount of money each year, and it reduces your taxable income based on how much you contribute. In this way, an RRSP allows you to defer your taxes while saving for retirement. For 2021, the RRSP contribution limit is $27,830; for 2020, it was $27,230; and for 2019, it was $26,500.

An important thing to note is that you will pay tax on this money once you withdraw it. When you turn 71, you can no longer contribute to your RRSP and must convert it into a registered retirement income fund (RRIF) that you can withdraw from. This is when you’ll start paying tax on the money you contributed. However, the idea is that, because you will be retired, you will be in a lower tax bracket than during your high-earning years, which means you will have paid less tax overall because you invested in an RRSP. 

TFSA vs RRSP: Which is better for you?

The best investment for you is going to depend on your individual financial situation and goals. Remember: With a TFSA, you pay tax on money you’ve earned before you make a contribution, and with an RRSP you get a tax refund now on money you contribute, but will have to pay tax later, when you withdraw money from the plan. This difference, along with your income, your investment timeline, and other factors will all contribute to making the right decision for your investment dollars. You may find that you can use both vehicles simultaneously. So, is it better to max out your TFSA or your RRSP? Read on to learn more.

1. Income and tax bracket

Your income determines your tax bracket—the amount of income tax you have to pay—and these factors will strongly influence which investments work best for you.