RRSPs and TFSAs: Which Vehicle for Which Journey

December 15, 2021

Photo of a human's shoes having to choose between two options

New investors often ask about the difference between Registered Retirement Savings Plans (RRSPs) and Tax-Free Savings Accounts (TFSAs). I like to refer to these investment vehicles as two separate buckets of money you’d use for different things.

RRSPs and TFSAs are similar in that they each offer the same potential for return. Money in each account can be used to buy any investment product available to Canadians, including individual stocks, securities, exchange traded funds (ETF’s), mutual funds, GIC’s and bonds. They differ most in the type of dollars that can be invested, and the timeline on which they can be withdrawn without penalty.

RRSP contributions are tax deductible which means contributions are deducted from your taxable income, which can increase your tax refund. The tax refund can then be put right back into the RRSP to fund the next years contribution. The tax on RRSP investments gets paid when the funds are withdrawn - presumably at retirement, when your income tax bracket is lower. Money withdrawn before retirement is charged a 10-30% withholding tax, you get a T4-RSP for the amount withdrawn so you may be subject to more income tax at your current rate; funds withdrawn can’t be replaced into your RSP. For these reasons, RRSP investments should be made with a long-term strategy.

TFSA contributions are made with after-tax dollars. Interest, dividends and capital gains earned in a TFSA are tax-free, unlike earnings in a common trading account, which are subject to tax. This money can be withdrawn without penalty at any time, but contribution limits are set by the Government of Canada on an annual basis. TFSA investments are typically made with a short or medium-term investment horizon. TFSAs are not intended to be used as a bank account or an active trading account, and are monitored by the Government of Canada to ensure they are not used as a means to avoid the tax on capital gains.
These are complementary tools to be used together.

For younger investors, and those not yet approaching retirement, a TFSA is one of the most powerful investing tools we have. Compared to the tax benefit of an RRSP contribution, TFSAs can offer a particularly compelling return to Albertans in the lower tax brackets, earning less than $95,000 per year.

TFSAs are commonly used to save for holidays, home renovations, and for emergency funds. They are also an important tool that self-employed or non-salaried workers can use to save money for the feast-or-famine cycles common to seasonal employment, contract work or entrepreneurship.

For those in higher earning brackets, or who have maximized their TFSA contributions, RRSPs can offer substantial tax savings and are powerful tools for compounding growth on investments. Withdrawal planning is more complex with RRSPs, especially for higher income earners with a defined benefit pension. Investors want to consider future tax rates, and avoid situations where RRSP withdrawals and pension money negatively impacts old age security income.

Our job as wealth advisors is to help you answer questions. There’s great satisfaction knowing we’ve picked the right tool at the right time to make sure both of your buckets are as full as possible to meet your investing goals.

Jane Alm, Senior Wealth Advisor

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