When it comes to saving, many young Canadians are confused about whether to put money into a TFSA vs RRSP. They can easily become overwhelmed by the complexity of both, that they choose neither, and miss out on the awesome tax advantages of both these accounts.
You should strive to have both a TFSA and an RRSP, but if you can only pick one, the TFSA is probably the right choice.
TFSA vs RRSP summary
The Tax-Free Savings Account (TFSA) and Registered Retirement Savings Plan (RRSP) are different enough that it takes some time to explain them well. However, if you’re in a hurry, here’s a brief run down comparison:
|Age to open account
|as soon as you have earned income
|Annual contribution limit
|18% of gross income earned
|up to $75,500 depending on birth year
|up to 18% of gross income earned
|Unused contribution room carried forward?
|Yes, but must be declared when you file taxes in order to be carried forward
|Penalty for over-contribution
|1% of over-contribution per month
|1% of over-contribution per month for amount in excess of $2,000
|cash, GICs, mutual funds, stocks, bonds, and ETFs
|cash, GICs, mutual funds, stocks, bonds, and ETFs
|can withdraw at any time for any reason without penalty
|can only withdraw during retirement, for the Lifelong Learning Plan, or the First Time Home Buyer’s Plan
|can contribution your entire lifetime
|must be converted to an RRIF at age 71
|All investment gains are tax-free
|All investment gains are tax-deferred
Want more info? Keep reading!
The TFSA and RRSP at a glance
Both the TFSA and the RRSP are tax-advantaged accounts, but they work in very different ways and have very different rules. They’re part of a family of registered accounts in Canada, that also includes the RESP. However, unlike the RESP, the TFSA and the RRSP are retirement savings tools. Here is a brief summary of each:
The Tax-Free Savings Account (TFSA)
The Tax-Free Savings Account was introduced in 2009 to help Canadians save money. Despite having “savings” in its name, this account can actually be more than a savings account. You can hold GICs, mutual funds, stocks, bonds, and ETFs in your TFSA. You can read more about the TFSA here.
The Registered Retirement Savings Plan (RRSP)
The Registered Retirement Savings Plan (RRSP) is a tax-deferred retirement savings tool. Despite having “savings” in its name, this account can also be used to invest. You can hold GICs, mutual funds, stocks, bonds, and ETFs in your RRSP. You can read more about the RRSP here.
Similarities between the RRSP and TFSA
Both the TFSA and RRSP are registered accounts. This means they are tied to your social insurance number and the Government of Canada monitors your contributions and withdrawals. This is because there are penalties to over-contributions to both accounts, as well as rules as to when you can open one (age 18 for the TFSA and have to have a taxable income for the RRSP) or what you can withdraw money for.
Both the Tax-Free Savings Account and Registered Retirement Savings Plan have “savings” in their name, but neither account is restricted to keeping your money as cash savings. In both the TFSA and RRSP you can hold a variety of investments including GICs, mutual funds, stocks, bonds, and ETFs.
Here are the ways the RRSP and TFSA are the same! Both the TFSA and RRSP:
- are registered accounts tied to your SIN (Social Insurance Number)
- have contribution limits
- can hold cash, mutual funds, GICs, stocks, bonds, ETFs
- tax-shelter investment income earned within each account
Both the TFSA and RRSP are fantastic savings vehicles for building long-term wealth. The primary purpose of both accounts should be retirement savings, but they can also both be used to save for a down-payment on a home or money to go back to school.
Differences between the TFSA and RRSP
Here are the differences between the TFSA and RRSP:
- age at which you can open an account
- annual contribution limits
- lifetime contribution limits
- when you can make a withdrawal
- what you can make withdrawals for
- there is no withholding tax on US dividend paying stocks in the RRSP, but there is withholding tax on the same in a TFSA
Opening and contributing to a TFSA vs RRSP
You need to be at least 18 to open a TFSA, but you can open an RRSP as soon as you start earning income. This means if you’re 17 years old and working part-time at Starbucks, you could open an RRSP right now (especially if they offer any kind of employer-matching!).
The contribution limit for the TFSA is the same for all Canadians: $6,000 per year. But the RRSP is income dependent, so the more you earn, the more you’re allowed to put into an RRSP. For high-earners, the RRSP is an excellent tax-shelter because it effectively lowers your taxable income. This is how many people get an income tax refund for making RRSP contributions.
Withdrawing from a TFSA vs RRSP
One of the biggest perks of the TFSA is the flexibility to withdraw from the account at any time, for any reason. As long as there’s money in your TFSA, you can use it for whatever you want! The RRSP, on the other hand, is designed almost exclusively to be a retirement savings tool. You can make special withdrawals under the First Time Home Buyers Plan or the Lifelong Learning Plan. However, these are loopholes and for the most part, you won’t be able to access the money in your RRSP until you actually retire.
Because it is completely tax-free, the TFSA is a superior savings vehicle to the RRSP. If you have the choice between raiding one account or the other for a purchase, you should always drain your RRSP first and leave your TFSA alone.
Should you choose the TFSA or the RRSP?
The short answer is everyone should have both a TFSA and an RRSP and striving to max out both accounts. However, since that’s not easy to do, what you want to focus on is prioritizing saving in the account that will benefit you the most.
The primary determinant as to whether you should save in an RRSP or a TFSA is your income. High earners should make the RRSP a priority over the TFSA, and low earners should focus on the TFSA before the RRSP. The easiest rule of thumb is to make the TFSA a priority if you make less than $50,000 per year, and the RRSP your focus if you make more than $50,000 per year.
I go through the math in this post: Should You Contribute to an RRSP or a TFSA?
Hope you found this post a helpful guide to the TFSA vs. RRSP when it comes to your savings goals!