Where to put your savings: RRSP or TFSA?

November 6, 2014

In order to decide whether you should put your savings into the RRSP or TFSA, or contribute to both, consider the following facts.

Where to put your savings: RRSP or TFSA?

The federal government has two useful savings vehicles for Canadians: the Registered Retirement Savings Plan (RRSP) and the Tax-Free Savings Account (TFSA).

  • Which is better depends on each individual's financial situation and savings priorities.

Tax treatment

The biggest difference between the RRSP and TFSA is how the contributions and withdrawals are treated for tax purposes.

Income tax and the RRSP

The money you contribute to an RRSP is not taxed, so if you have already paid income tax on that money through your employment, you will receive it back as a refund.

  • Any increase in the value of your money in the RRSP account through investment is not taxed.

Your RRSP money is not perpetually tax-free, however.

  • Any amount you withdraw is taxed at that time.
  • This is the basic reason that RRSPs were introduced; you are encouraged to make contributions and save on taxes during your high-earning, high-tax years, and make withdrawals during retirement when income is low or nonexistent, as is income tax.

Income tax and the TFSA

Your TFSA contributions come from after-tax dollars, so there's no tax break when you put your money in.

  • However, withdrawals are not taxed, and this includes any increase in the account balance accrued through investments, so your savings can grow tax-free until you need them.

One size doesn't fit all

As with anything in life, different people have different needs. In some circumstances, the TFSA makes good sense as a source of retirement income and RRSPs make good savings vehicles.

Borrowing from your RRSP

You can borrow from your RRSP without triggering taxes under the Home Buyers Plan and the Lifelong Learning Plan, but you must repay the money in a set amount of time.

  • For young people with money in RRSPs and no other savings, these two plans help with the big expenses of purchasing a first home and getting an education.
  • Before the TFSA was introduced in 2009, these were the most common uses of RRSP savings.

TFSA for retirement savings

In certain circumstances, RRSPs don't offer the intended benefits. For example, someone who wishes to work past the age of 71 can no longer contribute to an RRSP.

  • If this is the case, the individual must close the RRSP and start drawing income, which might push him/her into a higher tax bracket. Someone with a great pension might end up paying more taxes when RRSP withdrawals start.

Some of both

These two plans offer pros and cons that largely depend on an individual's circumstances.

  • The RRSP is great for middle- and high-income employees who contribute when their income is high and withdraw when it is low.
  • For people with a low income in retirement, TFSA withdrawals don't count as income and therefore don't impact entitlement to government benefits.

Ideally, you should try to contribute to both since they are good for different scenarios.

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