RRSPs vs. TFSAs

What is the difference and which one should you contribute to?

TFSAs and RRSPs are complementary government endorsed savings plans that offer valuable tax saving opportunites. The key difference between the two is when these tax savings occur: both RRSPs and TFSAs shelter you investment income from tax for the duration that contributions remain inside the registed account, but RRSP contributions are tax deffered and TFSA withdrawals are not subject to income tax. 

With RRSPs, essentially your income and interest earned is taxed when it is received, rather than when it is earned. Your annual income tax is calcuated on your gross income, minus your yearly RRSP contributions. You will receive a tax credit when you contribute to an RRSP, but will have to pay tax when you withdraw funds. The idea behind this is that you typically fall into a lower tax bracket when you retire, and thereby lower your overall tax liability by contributing to an RRSP. 

Unlike RRSPs, contributions made to TFSAs are with after tax dollars. You can contribute up to $5,500 of after tax dollars annually to your TFSA, and withdrawals are tax free. Because withdrawals are not subject to income tax, TFSAs are more flexible than RRSPs and can also be used for short term as well as long term saving.  

While there are many factors that determine which plan is best for you, all things equal, you should choose to contribute to:

  • an RRSP when you expect your pre-retirement income to be greater than your retirement income
  • a TFSA when you expect your pre-retirement income to be less than your retirement income
  • either a TFSA or an RRSP if you expect your pre-retirement income to match your retirement income
TFSAs RRSPs
Is investment income earned inside the registered account tax free? Yes Yes
Are contributions tax deductible?  No Yes, your income tax is calculated on your gross salary, minus your annual RRSP contributions
Is there tax on withdrawal? No Yes, withdrawals are taxed as income
What are the yearly contribution limits? $5,500 18% of earned income, up to a maximum of $24,930 (2015)
Do withdrawals increase contribution room? Yes, withdrawals increase contribution room in the year following a withdrawal No
Does unused room accumulate? Yes Yes
Do withdrawals affect eligibility for federal income-tested benefits and credits?  No, neither income earned within a TFSA nor withdrawals affect eligibility for Old Age Security, Guaranteed Income Supplement, Canada Child Tax Benefit  Yes
Are there penalties for over contributing?  Yes, 1% per month applies to excess contributions Yes, a 1% tax per month applies to excess contributions over $2,000
Best suited for...?

Long term and short term saving

Long-term (retirement) saving 

Investment vehicles

TFSAs and RRSPs allow you to invest in any investment vehicle, whether you choose mutual funds, equities, bonds, or GICs (to name a few). But which one should you contribute to? The answer depends on your personal financial objectives and investment goals. 

That said, when deciding which investments to hold within an RRSP or TFSA, a general rule of thumb is to try and shelter your investment income that has the least favourable tax treatment, such as interest income. That way you receive the greatest tax benefit from your TFSA or RRSP. 

Goals and expectations

When deciding between a TFSA and RRSP, ask yourself a few key questions. What are your saving goals? Are you saving for long term retirement, or do you have a shorter-term goal in mind, such as saving for a down payment on a house or new car? If your goal is to save for retirement, what tax bracket do you expect to fall into when you retire? 

There are also other factors to consider, including whether or not you plan on reinvesting your tax refund (you should), and whether you have a Registered Education Savings Plan (RESP) and education needs.

We're here to help

Still unsure of what to do? It’s not an easy decision. By discussing your financial goals, needs and expectations, the experts at G&F Financial Group can help come up with an appropriate investment strategy and Smart Money Plan™ that is right for you.