Helping you make wiser investment decisions

TFSA vs RRSP: How to decide between the two

June 27, 2020 Keph Senett
TFSA vs RRSP: How to decide between the two

Photo by Arif Riyanto on Unsplash

One of the most common questions out there is whether to invest in a registered retirement savings plan (RRSP) or a tax-free savings account (TFSA). Both will help you save, and save on taxes, but each works in different ways. Understanding these investments will help you know when to use one or the other—and when you can use both in tandem.

What is a TFSA?

First introduced to Canadians in 2009, the TFSA has proven to be very popular. Each year, you get an allotment of $6,000 available for your TFSA, which means that you can put that amount away, plus any rollover from previous years (assuming you were 18 or older in 2009, you have a lifetime limit of $69,500 as of 2020). This money has already been taxed—you contribute to a TFSA from your net income—so there’s no tax break at the time of contribution. But any gains you earn in a TFSA—whether it’s from a savings account, a high-growth index fund or another investment product—aren’t subject to capital gains tax, so you won’t owe any tax on your earnings when you make a withdrawal. 

What is an RRSP?

A registered retirement savings plan, or RRSP, allows you to invest up to 18% per year of your gross income, or $26,500—whichever is less—without paying income tax on that money. (If you invest with after-tax dollars, the tax will be refunded after you file your income tax return for that contribution year.) 

In this way, an RRSP allows you to defer your taxes while saving for retirement. The most important thing to understand is that you will pay tax on this money once you withdraw it. The idea is that, because you will be retired, you will be in a lower tax bracket than during your high-earning years, and so will pay less tax overall because you invested in an RRSP. 

TFSA vs RRSP: Which is better?

The “best” investment is going to depend on your individual financial situation and goals. Remember: with a TFSA, you pay tax on money you’ve earned before you make a contribution; and with an RRSP you get a tax refund now on money you contribute, but will have to pay tax later, on money you withdraw from the plan. This difference, along with your income, your investment timeline, and other factors will all contribute to making the right decision for your investment dollars. You may find that you can use both vehicles simultaneously. Read on to learn more.

1. Income and tax bracket

Which is better? The short answer:

  • RRSPs if you make over $50,000
  • TFSAs if you make under $50,000

Your income determines your tax bracket—the amount of income tax you have to pay—and these factors will strongly influence which investments work best for you. 

As a general rule, those making more than $50,000 annually will do well to invest in an RRSP. This is because the money you put in is tax deductible and your deductions go towards reducing what you owe. For those who make less than $50,000 per year, the deduction is less valuable, because after claiming basic tax credits, you aren’t likely to owe much income tax. In these cases, putting your money into a TFSA may make more sense.

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