RRSP or TFSA? Which is Best?

July 14, 2017

Years ago, when you wanted to save money for retirement, you had one option: Open a Registered Retirement Savings Account and start stuffing it with money. The RRSP was an easy choice and had the added perk of giving you a nice little tax refund every year.

But in 2009 that changed when Finance Minister Jim Flaherty introduced Canadians to the Tax-Free Savings Account. Suddenly there was more than one option, and the debate between choosing an RRSP or TFSA was born. It’s still ongoing, so let’s look at some of the pros and cons of each option below.

Registered Retirement Savings Plan

When you contribute to an RRSP, you don’t have to pay tax on the money you contribute. If you contribute with your after-tax dollars, you’ll get a refund when you file your taxes. The money in this account will grow tax-free, but when you withdraw it, you have to pay tax on it.

There are only two instances where you can withdraw money from your RRSP without paying that tax hit: under The Home Buyers’ Plan when you buy a home, and under the Lifelong Learning Plan if you choose to return to school. In both instances, you have to pay back the money you withdrew. Otherwise you’ll have to pay tax on it.

You RRSP account also has a limit of how much you can contribute. You can contribute up to 18% of your earned income, up to a maximum of $26,010 per year. Everyone’s contribution limit is different, and you can check yours by reading your income tax notice of assessment.

The RRSP can be a great way to save for retirement because once you contribute to it, you can’t withdraw the money without incurring penalties. These penalties make it less likely that you’ll withdraw it for another purpose.

The biggest drawback to an RRSP is that when you withdraw the money in retirement, you have to pay tax on it. Many Canadians forget this simple fact when determining how much money they need in retirement, and it can lead to some serious belt tightening or working a few years extra.

Tax-Free Savings Account

 The TFSA is a popular long-term savings account because it is simple and easy to understand. As I mentioned earlier, it was introduced in 2009, and the annual contribution limit was $5,000 per year. In 2013 the contribution limit was raised to $5,500, and in 2014 it was raised to $10,000 before being lowered in 2016 back to $5,500. If all of that sounds a little confusing, just know that if you were 18 years of age in 2009, your total contribution room is $52,000.

The TFSA differs from the RRSP in one key way: how your contributions are taxed. When you contribute to your TFSA, you don’t get a deduction on your taxes. So, if you contribute with your after-tax dollars, you won’t get a refund. Since you already paid tax on the money, it can grow tax-free inside your TFSA and then you don’t pay any additional tax on it when you withdraw (because you already did when you contributed). That means the money that is inside your TFSA is your money, and you don’t need to do any additional calculations in your retirement projections.

Because there are no penalties when you withdraw money from your TFSA, it has become a popular savings vehicle for big goals like a home down payment or emergency fund. While these are certainly good uses for the TFSA, it also makes a great retirement savings account, as long as you have the discipline to leave the money in there to allow it to grow and not withdraw it.

If you do need to withdraw money from your TFSA for some reason, you’ll get that contribution room back in the next calendar year, not right away. It’s important to remember this because if you pay the money back and over-contribute, you’ll pay a penalty at tax time. Make sure to keep track of the balance of your TFSA relative to your overall contribution limits to avoid this mistake.

So which is better? The TFSA or the RRSP? Personally, I think the RRSP is a great way to save for your long-term future, because the money is locked away and inaccessible to you, which means you’ll be less likely to raid that account for today’s wants or needs.

If you are confident in your ability to save for retirement in an account that you can access with no penalties, the TFSA is also a good choice. Alternatively, the TFSA is a popular option for saving large amounts of cash such as for a home down payment or emergency fund.

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