TFSA vs RRSP: Benefits & How to Choose

Last Updated on 8 months by Anoob P T

Wondering how to choose between TFSA vs RRSP? Here are benefits of TFSA vs RRSP and how to choose based on your requirements such as time or income.

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TFSA vs RRSP: Benefits & How to Choose

What is a TFSA?

TFSA is a Tax-free Service account that was brought out in 2009 by the Canadian government.

It was put in place to promote and inculcate the habit of savings and investment among the citizens.

Even though the moniker states savings account, TFSA deals with investment, under which you are eligible to hold any security stocks bonds, mutual funds as well as  ETFs.

It is registered with the Canada Revenue Agency (CRA)  to provide specific tax benefits. TFSA is also a tax sheltered plan which means that you don’t have to pay taxes on  any income that you receive within the TFSA.

However if you’re holding a US stock that pays US dividends those dividends are subject to a 15% withholding tax.

Canadian dividend paying stocks are more favorable to hold rather than receiving US dividends within the TFSA.

The criteria for signing up for a TFSA is that you have to be 18 years or older, it is not based on your income. 

TFSAs  have a $ 6000 contribution limit, you cannot pile up as much money as you want. Any amount that you don’t use is carried over to the next year.

TFSA withdrawals can be made any time and they are completely tax-free. The money that you withdraw from your TFSA can be recontributed in the next calendar year and it is not included in the contribution limit.

The contributions to TFSA  are not tax deductible so it’s not like the RRSP where you can deduct it from your  taxable income, the money that you contribute to your TFSA is technically after-tax dollars.

You can actually open as many TFSAs as you want you can have a but the limit will split between the accounts. 

Official website to know more about TFSA: https://www.canada.ca/en/revenue-agency/services/forms-publications/publications/rc4466/tax-free-savings-account-tfsa-guide-individuals.html

What is a RRSP?

RRSP or the Registered retirement savings plan is an  investment account similar to TFSA. RRSP is also tax-sheltered.

What makes RRSP unique is tax-deferring which lets you pay taxes later. The amount of money that you contribute to your RRSP can be deducted from your taxable income, hence saving you money.

When you take money out of your RRSP you have to know you have to include that amount in your taxable income for that year.

The whole idea behind deferring these taxes is that during your high income years when you’re working hard and you’re likely going to be in a higher tax bracket you can use the RRSP and save money on taxes.

You can take money out of your RRSP whenever you want but when you turn 71 your RRSP is going to be converted into a Retirement Income Fund and there’s gonna be a minimum amount that you have to start taking out so eventually you will have to start paying taxes on these. 

The contribution limit for an RRSP account is set at 18% of the previous year’s income.  You can over contribute to your RRSP by $ 2000 without paying a penalty.But if you go a dollar over that you will have to pay a penalty of 1% per month until you fix it. 

When you take money out of your RRSP you don’t get that contribution space back unlike with TFSA where  if you take money out the next calendar year you’re able to put that back in.

With RRSP once you take money out that’s gone. It’s not about the growth or the size of your portfolio.

Your contribution space is determined by the amount of deposits that you make . RRSPs are especially useful for somebody that finds themselves in a higher tax bracket  from saving money. 

Official website of RRSP

TFSA vs RRSP which is better?

When you compare TFSA vs RRSP, you need to take into account few factors which make the choice ideal for your use case.

Based on time

For the short-term outlook TFSA would be favourable as it is a much more flexible account in terms of taking money out. When you withdraw money from your TFSA you actually get that contribution space back in the next calendar year. You can also access it easily. 

In RRSP when you take money out  you don’t get that contribution back once that’s out. RRSP is advisable for the long term for your retirement. 

Buying your first home or saving for education

RRSP is better for a house investment as you can take money out of your RRSP through the Home Buyers plan.

If you’re looking to buy or even build a house you are eligible to withdraw up to $25,000 from your RRSP and this withdrawal can be done tax-free. This has to be a qualified house and be located in Canada.

It has to be your primary residence. 

By taking that money out you have up to 15 years to repay that amount so you’re essentially taking a loan out from yourself from your RRSP account. 

Under the Lifelong Learning Plan (LLP) you can utilize upto $20,000 of your savings for the education of your children. This can be done over the span of two years and the amount should be repaid within 10 years. 

Based on Income

RRSP is very beneficial for somebody that is in a high tax bracket.

With an RRSP when you put money in you can defer paying taxes. You can actually get a tax break and worry about paying those taxes late.

If you’re somebody that finds yourself in a high income bracket you are really getting the most out of your money by utilizing RRSP.

The money that you are contributing there, what you are saving on taxes, it’s at that highest bracket it’s at your marginal rate that you are pushing off and deferring.

RRSP is a great account to use to defer at a high rate and then years down the road you can let it grow tax-free. Then when you’re ideally in a low tax bracket or in retirement that’s when you can start peeling it out.

If you’re not concerned whatsoever with your tax situation you could default to the TFSA because of the flexibility, overall how simple it is to use.

But of course with the TFSA you are going to be using after-tax dollars,  there’s no tax break. It’s just a very simple account where you can put money in, let it grow and pull it out when you feel like. 

If you hold a US stock in your TFSA and it pays a dividend subject to a 15% withholding tax meaning that the IRS over in the States will withhold 15% and what you actually get in your account in terms of the dividend is actually 15% less of the entire dividend. 

In a RRSP the exact same stock with the exact same dividends in a retirement account are not subject to tax withholding tax.

You are actually going to be receiving 15% more by simply holding your US dividend stocks in your RRSP.

In terms of Canadian stocks  it doesn’t matter as there’s no withholding tax on the dividends there. 

Group Plans 

For Group plans RRSP is more valuable as in most cases your company will match a percentage of your salary to the percentage you invest.

You are essentially getting free money as an automatic return on your investment. This works in a similar manner for a tax-deferred account or your pension plan with a defined contribution.

Such kind of money would not be easy to earn through any other form of investments.  

For Retirement

RSSP is better because of its tax deferring option.

That gives you more money to invest and then ideally when you’re in retirement and in a much lower tax bracket that’s when you start peeling the money out and pay a much lower amount in taxes 

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