Last Updated on January 7, 2022 by Yetty Akindele
When you decide to save for your future, you’re on the right track. The only problem is you have to make a big decision. The question of which account type to choose between a TFSA and RRSP is one that poses a dilemma for some people. Many Canadians in your position are stuck between choosing to open an RRSP or a TFSA. Some people also consider whether it makes more sense to just open one of each.
Both account types will help you reach your long-term financial goals if you’re consistent. You can even use automated options like pre-authorized contribution plans or Robo-advisors to help. However, before you do that, you will need to consider what each of these registered account types can offer you.
The TFSA and RRSP are tax-sheltered investment options. Your specific financial situation might make one option better than the other.
It’s Easier Than You Think
Choosing between an RRSP or TFSA is easier than you think.
A TFSA is a flexible account that provides far more tax sheltering for growth. However, TFSAs also have much smaller contribution limits than RRSPs.
RRSPs allow you to save significantly more money. However, the rules around withdrawals and what you can take them for are much stricter than those for TFSAs. This is why it’s a good idea to try to use both accounts if you can., so you maximize the benefit that both account types have to offer.
If you have to choose one option, it makes sense to choose an RRSP if you have a high income and want to save strictly for your retirement. If you want a tax-free investment account that you can withdraw from more liberally, but with a smaller balance, it makes sense to choose a TFSA. Having one of each allows you to reap all these benefits.
The Main Differences Between TFSAs & RRSPs
The biggest difference between these accounts is how income is taxed upon withdrawal or contribution.
A tax-free savings account (TFSA) is a tax-free account. Your contributions to the account are from after-tax income. That means you won’t pay any income when you withdraw funds. Any income from investments or interest in a TFSA in most instances is not taxed.
An RRSP is a tax-deferred retirement savings account. Any contributions you make to the plan can be deducted from your income taxes. You can contribute your pre-tax income to lower your taxes for the tax year. You will then end up paying income tax when you start withdrawing funds from your RRSP later.
Because of how these accounts are structured, you will normally end up with a similar balance in the end. That’s why deciding between a TFSA, RRSP, or both isn’t too stressful. That’s assuming you contribute to either account in the same way…
A Quick Guide Through The TFSA
The TFSA was created in 2009. It was launched to give Canadians a more flexible long or short-term savings option. While it wasn’t expressly created for retirement savings, it can be a great tool for that purpose. However, unlike an RRSP, a TFSA can be used for anything else as well.
There are several important considerations to remember with a TFSA. First, it’s an easier account to use. It allows you to contribute and withdraw at your leisure. When the account is producing income from dividends, interest, or other investment income, that income is not taxable excluding certain types of investments.
If you withdraw from a TFSA, you can still replace the withdrawal amount during the same year if you have contribution space. However, If you no longer have a contribution room for that year, then you can contribute any amount withdrawn the next year.
You can open a TFSA anytime from your 18th birthday until your death. There are no expiry dates or limits, apart from the one huge drawback to a TFSA:
TFSA contributions are limited to $6,000 per year for 2019 and 2020. For most years before that, the limit was $5,000 or $5,500.
These limits fall far short of the contribution limits of an RRSP.
A Quick Guide Through The RRSP
The RRSP is the older long-term savings account. Launched in 1957, the account is meant strictly to help Canadians prepare for retirement.
To encourage you to contribute to an RRSP, the CRA allows you to claim tax deductions on contributions you make to an RRSP on the year they were made. However, unlike a TFSA, your RRSP savings are taxed later once you start withdrawing funds. You must also convert your RRSP into a Registered Retirement Income Fund (RRIF) before December 31st of the year you turn 71.
Contribution limits for an RRSP are multiple times higher than those of a TFSA. You are allowed to contribute up to a limit of 18% of your earned income. In 2021, the maximum was up to $27,830. For 2022, the maximum RRSP contribution limit is up to $29,210. So, if you want to start preparing a very large nest egg for retirement right now, an RRSP must be a part of your plan.
Withdrawing From An RRSP
Despite the limits we’ve mentioned, you can still withdraw funds from an RRSP before retirement. However, you will have to repay the amount, and you can only withdraw early without penalty for these 2 reasons:
- A Home Buyers Plan
- A Lifelong Learning Plan
The Home Buyers Plan allows you to withdraw up to $35,000 for a mortgage down payment on your first home. You must repay it over 15 years.
The Lifelong Learning Plan allows you to withdraw $10,000 to $20,000 per year for educational expenses. You must repay the total amount over 10 years.
The higher your income is, the more you benefit from the tax deferments of an RRSP. Lower income brackets are taxed at a lower percentage rate, which removes part of the tax benefits an RRSP provides. For those earning in the highest tax bracket, the tax benefits are immense. Contributions are subtracted from your taxable income. So, you can even lower yourself into a less-taxed bracket.
Many employers only offer pension-matching for RRSP contributions. If your employer is like this, you should certainly invest in an RRSP.
How To Invest In A TFSA Or RRSP
There are many options for TFSA or RRSP investments. If you want safety, a high-interest savings account will provide that. However, the “savings” in each acronym are misleading, as these accounts are meant to be an investment as well. To take full advantage of the amazing tax benefits these accounts are afforded, an investment account is necessary.
You can open either account type with an online discount brokerage. This allows you to invest in ETFs, stocks, bonds, and certain other investment types.
Robo-advisors are another online option. If you want to open a low-fee, relatively hands-off investing TFSA or RRSP, Robo-advisors will manage a portfolio for you.
Robo-advisors can be used to manage an ETF profile. But the profile will be based on a questionnaire that accounts for your risk tolerance and other factors.
TFSA High-Interest Savings Accounts
If you want a simple addition to your long-term savings plan, consider a high-interest savings account. These accounts don’t produce appreciable income.
However, if you just want to store some of your money (emergency fund), for now, they provide interest rates that help your savings keep up with inflation.
The Best TFSA accounts
Questrade offers one of the best deals for a TFSA account. If you want more control over your portfolio, you can open a direct investment TFSA with them. Unlike many of their alternatives, you don’t have to pay monthly management fees.
Read my complete Questrade review here.
Wealthsimple invest is a Robo-advisor that offers the most well-rounded Robo-advisor TFSA we could find. You can start investing with a free $10 when you open your first account and deposit at least $100.
Wealthsimple also offers you more professional support than other robo-advisor platforms. With some of their plans, you can have a financial advisor help you come up with the right portfolio for you.
Read my complete Wealthsimple Invest review here
Known for offering above-the-market interest rates on traditional savings account, EQ Bank currently offers 125x interest on savings more than most other banks in Canada. Until January 20th, 2022, you can earn 2.00% interest on a TFSA 3-month GIC.
The Best RRSP accounts
Wealthsimple offers the same services as with the TFSA for RRSP.
EQ Bank offers an RSP with high interest. The limited-time 2.00% interest on a 3-month GIC also applies to a GIC RSP account with EQ Bank. You also get to enjoy all the tax advantages of an RRSP.
If you already have a retirement savings plan that you can remain consistent on, you have nothing to worry about. A TFSA or an RRSP will both serve you well. The important thing is how you treat retirement savings as a whole. Your choice in retirement accounts comes second to that.
While both accounts offer great benefits, it’s important to weigh their pros and cons before you dedicate significant savings to either. TFSAs offer you more freedom than RRSPs. But if you want to maximize your retirement savings, it’s best to contribute to an RRSP. Ideally, you’re in the position to do both.