TFSA vs RRSP: How to decide between the two

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 a different way. Understanding how these accounts work will help you decide which is best for your current needs—and even when to use them in tandem.

What is a TFSA?

A TFSA (or tax-free savings account) is a registered investment savings account that any Canadian resident, aged 18 or older, can use for straightforward savings or to hold investments. It can store things like exchange-traded funds (ETFs), guaranteed investment certificates (GICs), bonds, stocks and cash.

Any income earned in the account—even when it is withdrawn—is tax-free. This means any interest, stock dividends and capital gains earned in your TFSA aren’t subject to income tax. However, your TFSA contributions won’t reduce your taxable income like RRSP contributions will.

There’s a limit on the amount of money you can contribute to your TFSA is annually. However, you can carry forward the unused contribution room to a current lifetime maximum amount. Each year, you get an allotment of around $6,000 available for your TFSA, which means that you can put that amount away, plus any rollover from previous years (to find out how much room you have left, use this contribution room calculator).

So how is a TFSA tax-free? The money you put into this account 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. Plus, any gains you earn on those investments will not affect your contribution room for the current year or years to come, either. Essentially, you don’t pay tax on the money you make in your TFSA.

What is an RRSP?

A registered retirement savings plan, or RRSP, works similar to a TFSA, in that it can hold savings and investments. A significant perk of this account is that it allows you to contribute a large amount of money each year, and it reduces your taxable income based on how much you contribute. In this way, an RRSP allows you to defer your taxes while saving for retirement. For 2021, the RRSP contribution limit is $27,830; for 2020, it was $27,230; and for 2019, it was $26,500.

An important thing to note is that you will pay tax on this money once you withdraw it. When you turn 71, you can no longer contribute to your RRSP and must convert it into a registered retirement income fund (RRIF) that you can withdraw from. This is when you’ll start paying tax on the money you contributed. However, the idea is that, because you will be retired, you will be in a lower tax bracket than during your high-earning years, which means you will have paid less tax overall because you invested in an RRSP.

TFSA vs RRSP: Which is better for you?

The best investment for you 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, when you withdraw money 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. So, is it better to max out your TFSA or your RRSP? Read on to learn more.

1. Income and tax bracket

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. Here’s a chart of the Canadian tax brackets to help you determine yours:

Annual Income (Taxable)	Tax Brackets	Tax Rates	Maximum Taxes Per Bracket	Maximum Total Tax
Up to $49,020	The first $49,020	15%	$7,353	$7,353
$49,020 to $98,040	The next $49,020	20.5%	$10,049.10	$17,402.10 ($7,353 + $10,049.10)
$98,040 to $151,978	The next $53,938	26%	$14,023.88	$31,425.98 ($17,402.10 + $14,023.88
$151,978 to $216,511	The next $64,533	29%	$18,714.57	$50,140.55 ($31,425.98 + $18,714.57)
Over $216,511	Over $216,511	33%	n/a	n/a

Which is better? The short answer:

If you make over $50,000 — RRSP
If you make under $50,000 — TFSA

Compare the best TFSA rates in Canada*

2. Time horizon

Anytime you make an investment, it’s a good idea to identify exactly what you’re saving for. Putting away money for retirement is usually on a longer timeline than, say, your child’s education fund or a home renovation.

Your RRSP money is earmarked for your retirement. The program is designed so that when you withdraw the money you will be earning less, and will therefore find yourself in a lower tax bracket, meaning you will pay less overall tax in your lifetime. This works well for its intended purpose but does not help you with short- or medium-term goals. That’s where a TFSA might work better, given that you can make withdrawals tax-free, and with no penalties. Money invested in a TFSA could easily be withdrawn to buy a car, for example, with no tax implications.

Which is better? The short answer:

For longer term savings goals, like retirement — RRSP
For short- or medium-term savings goals, like an emergency fund or buying a car — TFSA

Compare the best RRSP investments*

3. Group plans

If you receive a matching contribution from your employer on a group RRSP or a similar tax-deferred account like a defined contribution (DC) pension plan, investing in your RRSP could be even more valuable than usual. The way employer contributions tend to work is that your company will match a percentage of your salary when you invest the same percentage, or a percentage of what you contribute—sometimes dollar for dollar. This free money is an automatic return on your investment that would be pretty much impossible to obtain through investing.

Let’s look a little closer. An employer match of even 2% on a $70,000 income results in an extra $1,400 in your RRSP—and your employer’s portion of the contribution may also count towards your RRSP deduction for tax purposes. This is a double benefit and will likely tilt your preference in favour of a workplace account over other savings options unless the match is low, or the investment options are terrible.

Which is better? The short answer:

Almost always RRSPs if your contributions are matched by your employer (it’s free money, after all)

4. Buying your first home or saving for education

Remember how your RRSP is designed for your retirement? There are a few notable exceptions to that, in the form of the Home Buyers’ Plan, and the Lifelong Learning Plan.

The Home Buyers Plan (HBP) allows eligible home-buyers to withdraw up to $35,000 from their RRSP to put towards their purchase. The withdrawal is tax-free and must be repaid within 15 years. This is a great way to access a large lump sum, like for a down payment, and though it must be repaid, the “loan” is interest-free.

Similarly, the Lifelong Learning Plan (LLP) is a program that allows you to use your RRSP savings towards your own (or your spouse’s) full-time education or training, up to $20,000 over two years. The amount must be repaid within 10 years.

Which is better? The short answer:

Usually RRSPs, due to the availability of the Home Buyers’ Plan and Lifelong Learning Plan

5. In retirement

Withdrawals from TFSAs are always tax-free, whether you’re working or retired. Withdrawals from RRSPs are always taxable. If you’re in retirement, you are likely in a lower tax bracket than prior to your retirement, which means that RRSP withdrawals will be taxed at a lower rate than when you earned the money you originally contributed. Tip: If you find that you have a tax refund, you can maximize it by reinvesting the balance into a TFSA.

When saving and planning for retirement, it pays to take a considered and long-term approach with your decisions—and to personalize them. Whether on your own or with a professional, retirement planning can help validate your choices and assist you to set targets for the future.

Which is better? The short answer:

Almost always RRSPs (but it depends on your income, as covered in section 1)

This article was first published on June 27, 2020. It was last updated on March 29, 2022.

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TFSA vs RRSP: How to decide between the two

What is a TFSA?

What is an RRSP?