TFSA vs RRSP, Canada: Know the Difference between RRSP and TFSA

Are you wondering about the better choice between TFSA vs RRSP? This is one popular question out there.

The decision of whether to invest in a Tax-Free Savings Account (TFSA) or a Registered Retirement Savings Plan (RRSP) is one many people find confusing.

Both accounts help you save for retirement, offer tax benefits but work differently. A good strategy is to take advantage of both accounts and contribute as much as possible to both of them.

However, if you have to choose one, you should understand them and know how they differ. That’s the goal of this post— to help you see the difference between TFSA vs RRSP and choose the best one that matches your tax and financial situation. Read on!

Let’s find out the criteria to determine which is better for you, the top TFSA vs RRSP banks, and how you can invest your TFSAs and RRSPs.

Shall we?

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Quick Overview: TFSA or RRSP

Before we proceed to break down TFSAs and RRSPs, this is a quick comparison of TFSA vs RRSP:

	TFSA	RRSP
Tax-deductible contributions	No	Yes
Age-limit for contributions	No	Yes
Requires earned income to contribute	No	Yes
Tax-free withdrawals	Yes	No

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Breakdown of the TFSA?

Tax Free Savings Account (TFSA) was introduced to Canadians in 2009 and has been popular since then. Just like the RRSP, the TFSA is best for retirement savings. However, you can also use the TFSA for anything else. Let’s break down the details of the TFSA into 5 points: 

• You have to be 18 years or older to open a TFSA, there’s no expiry, and the contribution limit as of 2020 was $69,500. 
• TFSA is very flexible. Your account is tax-sheltered, and you can withdraw at any time without penalties.
• The money you contribute to a TFSA has already been taxed, so you contribute from your net income, meaning no tax break at contribution times. 
• Your earnings in your TFSA are not subject to capital gains tax. In other words, when you make a withdrawal, you won’t pay any tax on your earnings.   
• After a TFSA withdrawal, you can only replace the amount you withdrew in the same year if you still have available contribution room. Otherwise, you’ll pay the penalty. They’ll return the contribution room the following year. 

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What is an RRSP?

The RRSP has been in operation since 1957 and has been helping Canadians save for retirement. Let’s break it down into six points:

➤ A Registered Retirement Savings Plan (RRSP) allows you to contribute to whichever is less out of 18% of your gross income per year, or $26,500. You can carry forward unused contribution room to the next year.

➤ Since you make your RRSP contributions with pre-tax income, you can ask for a tax deduction when you contribute. However, if you don’t re-invest your tax refund, you may not get pre-tax benefits.

➤ If you make your RRSP contribution with after-tax dollars, you will get a tax refund when you file your income tax return for that year. So, you won’t pay income tax on your contributions and you can defer your taxes and concentrate on saving for retirement.

➤ Unlike a TFSA, you will pay tax when you withdraw from your RRSP. The logic behind this is since you will be in a lower tax bracket during retirement, you’ll pay less overall.

➤ You have to convert your RRSP to a Registered Retirement Income Fund (RRIF) by December 31 of the year you turn 71 years old.

➤ Two exceptions allow you to withdraw funds from your RRSP for motives different from retirement and repay the amount over a specified period. They are:

• Lifelong Learning Plan – You can withdraw up to $10,000 yearly to a maximum of $20,000 for school purposes. Then, you’ll have to repay the amount over ten years)

• Home Buyers Plan – You can withdraw up to $35,000 to make a down-payment on your first home. You’ll have to repay it over 15 years.

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TFSA vs RRSP: The Primary Differences Between RRSP and TFSA

TFSA vs RRSP’s primary difference is how your income gets taxed when you withdraw money or contribute to each account. While the TFSA is a tax-free account, i.e., what you contribute to it is your after-tax income, and you won’t have to pay income tax on withdrawals, the RRSP, on the other hand, is a tax-deferred account. 

In other words, you contribute to your RRSP with pre-tax dollars, so when you withdraw, you’ll have to pay income tax. Looking at this tax structure, whether you choose the TFSA or the RRSP, you should still end up with the same amount of money. 

Let’s use the table below to give us a general idea of what happens when you put your earned income in a TFSA vs RRSP.

Variables	TFSA	RRSP
Income earned (Gross)	$2,000	$2,000
Income tax at 30%	$600	$0
Net Contribution	$1,400	$2,000
Value after 30 years (6%)	$8, 040	$11, 486
Income tax on withdrawals (30%)	$0	$3, 446
Net Value	$8,040	$8,040

Note the assumptions of the table:

• You deposit the refund you get into your RRSP if you claim your RRSP contribution at tax time. 
• The calculations would be different if you contribute to your RRSP and claim them when you file your income tax, but you fail to top up your investment with the tax benefit. 
• The third assumption of this calculation is that you know your marginal tax rate during retirement. This is, however, very tough to predict, especially if you are in your 20s or 30s. 

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TFSA vs RRSP, Canada: 5 Criteria to Determine Which is Better for You

There is no one “best” investment plan. To know the best one for you, you’ll have to be aware of your goals and personal finance. While you pay tax on your money before contributing to a TFSA, you get a tax refund on your RRSP contribution and pay tax later at withdrawal.

This and other factors are what determine the right savings plan for you. You might even be able to use them both simultaneously. Let’s discuss these factors:

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1. Your Income and Tax Bracket

The first thing to note is your income decides your tax bracket. The amount of income tax you pay largely affects which investments suites you best. 

The general rule of thumb is people who make above $50,000 yearly are better off investing in an RRSP. The reason is your RRSP contributions are tax-deductible, and those deductions help reduce what you owe. 

On the other hand, tax deductions for people making less than $50,000 are less valuable. This is because after the basic tax credits have been claimed, what’s left of the income tax you owe will likely be little. In this case, it makes more sense to put your money into a TFSA. 

Pro-Tip on TFSA vs RRSP:

• Invest in TFSAs if you make under $50,000.
• Invest in RRSPs if you make more than $50,000.

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2. Short-Term & Long-Term Savings Goals

While you are making an investment, you must identify what your goals are. Putting money away for retirement is a long-term goal compared to short-term and more urgent demands like a home renovation or your child’s tuition. 

For RRSP, your investments are tagged for retirement. It is designed so that you’ll withdraw at retirement when you are in a lower tax bracket and pay less tax altogether. However, this does not help you with your medium or short-term goals. 

That is where a TFSA comes in. With TFSA, you can withdraw your funds tax-free and without penalties. 

Pro-Tip on TFSA vs RRSP:

• Invest in TFSAs for urgent short or medium-term savings goals, such as home renovation.  
• Invest in RRSPs for longer-term savings goals like when you are saving for retirement.

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3. When Buying your First Home or Saving for Education

Earlier, we mentioned the two exceptions that allow you to withdraw money from your RRSP account for purposes other than retirement – The home buyers plan and Lifelong Learning Plan.  

With the Home Buyers Plan (HBP), you can withdraw up to $35,000 to buy your home if you are eligible. It is a great way to obtain a lump sum for something like a down payment. The withdrawal is interest-free, tax-free, and you have to repay it within fifteen years.   

Likewise, the Lifelong Learning Plan (LLP) allows you to withdraw up to $20,000 over two years from your RRSP savings to sponsor you or your spouse’s full-time education. You have to repay it within ten years. 

Overall TFSA vs RRSP:

If you are looking to buy your first home or save for education, RRSPs are usually more preferable because of the Home Buyers’ Plan and Lifelong Learning Plan.

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4. Group Saving Plans

If your employer gives you a matching contribution on a group RRSP or other tax-deferred accounts like a defined contribution (DC) pension plan, you’ll receive more value if you invest in your RRSP. 

This is how employer contributions work: Your company matches the percentage of your salary that you contribute or invest. This is free money, and it is an automatic return on your investment—something that would be quite impossible to get through investing.        

For example, if your employer matches even as little as 2% on an $80,000 income. You’ll get an extra $1,600 in your RRSP which may also count regarding your RRSP tax deductions.

You’ll benefit in two forms, withdrawals’ tax rates which may even make you prefer your workplace account over other savings options. 

Overall TFSA vs RRSP:

If your employer gives you a matching contribution, an RRSP is better. 

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5. During Retirement

All withdrawals from TFSAs are tax-free, irrespective of if you are still working or retired. On the other hand, RRSP withdrawals are always taxable. However, when you are working, you are in a much higher tax bracket than during retirement.

But retirement means you are in a lower tax bracket, so your RRSP withdrawals’ tax rates will be lower than when you earned the money you contributed. If you are given a tax refund, an excellent idea is to reinvest the balance into a TFSA to maximize it. 

Overall TFSA vs RRSP:

In retirement, RRSPs are better. However, it depends on your annual income as we mentioned in the first point. 

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Comparing the Top 4 TFSA and RRSP Bank Accounts in Canada

Keeping some savings stored in your TFSA or RRSP account to complement your investment is a smart move that’ll come in handy if you later need access to quick cash.

You can achieve this if you open your Tax-Free Savings Account (TFSA) or RRSP with a bank that offers a high-interest rate.

Let’s look at the best four in the table below.

Bank	RRSP Rate	TFSA Rate
Tangerine	First five months = 2.10%, and subsequently, you’ll earn 0.10%	First five months = 2.10%, and subsequently, you’ll earn 0.10%
EQ Bank	1.25%	1.25%
Motive Financial	$0 to $2,500 earns 0.25%, $2,500.01+ earns 1.25%	Earn 2.20%
Implicity Financial	2.1%	2.1%

From the table above, you can see the banks that have the most spectacular rates in Canada. Overall, you should have both a TFSA and RRSP. However, don’t forget to shop around for the best before you decide on one. 

If you are looking to have some money saved up for the short-term, then you should open a TFSA or RRSP savings account with a bank that gives a high-interest rate.

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How do You Invest Your TFSA or RRSP

TFSAs and RRSPs are more investment accounts than they are savings accounts. To actually maximize your TFSA or RRSP, you should open an investment account. If you invest in long-term equities with your RRSP or TFSA, you can hold a considerable amount of investment earnings. 

Thankfully we are in a digital world, so opening and investing your TFSA or RRSP is effortless. You have several options.

If you are comfortable trading on your own, you can open your TFSA or RRSP investing account with an online brokerage and get a low fee Exchange Traded Funds (ETFs). 

However, if you want a little guidance in addition to low fees, then you should open your TFSA or RRSP investing account with a Robo advisor. That way you get to choose a portfolio of ETFs that fits your risk profile. 

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Using an Online Brokerage

If you’re okay with Do-It-Yourself (DIY) investing, you could decide to either create your personal retirement investment plan or recreate some Robo advisors’ portfolios. What you’ll do is to set up an RRSP or TFSA investing account with an online brokerage and then make trades yourself. 

Although you have to pay for some of your transactions, altogether, you’ll likely have a lower Management Expense Ratio (MER) than if you used Robo advisors.

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Using Robo Advisors

If you want guidance, growth, and low fees, then using Canada’s Robo advisors for your TFSA or RRSP investments is ideal.

What you have to do is sign up for a robo-advisor, answer a list of questions, and then the computer algorithm will suggest the best portfolio for you based on risk tolerance and financial goals. 

After that, you’ll set up pre-authorized contributions and leave the rest to the Robo advisor. The Robo advisor will monitor and rebalance your portfolio at a lesser fee than mutual funds and traditional financial advisors charge.  

Let’s compare some of Canada’s best robo advisors below:

Online Investment Platform	Rank
Wealthsimple	Overall Best
RBC InvestEase	Overall Best Big 5 Bank Robo Advisor. Promo: Receive $25 for you to invest with RBC InvestEase.
Questwealth Portfolios	Best for Highly Competitive Fees
Modern Advisor	Best for Professional Assembled Portfolio
BMO SmartFolio	Best for Sense of Human Touch
WealthBar	Best for Private Investment Portfolios Access
Just Wealth	Best for- RESPs

Wealthsimple stands out as the best overall robo advisor because of its low fees, user-friendly platform, and superb customer service. On the other hand, RBC InvestEase is the best overall robo advisor among Canada’s Big 5 banks.

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Frequently Asked Questions on TFSA vs RRSP, Canada

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Final Thoughts on TFSA vs RRSP, Canada

When you are faced with deciding between TFSA and RRSP for your retirement savings options, the ideal thing to do is to spread out your savings on both accounts. Due to the tax structure, you’ll probably come out with the same amount of money whether you use an RRSP or TFSA. 

The important thing now is to take a personalized, well-thought-out, and long-term approach to your decision.

Start saving now and contribute regularly to your TFSA or RRSP accounts (or both). That way, you can set future targets and have all your grounds covered for retirement.

Read Also -> RSP vs RRSP

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