The Registered Retirement Savings Plan (RRSP) and the Tax Free Savings Account (TFSA) are both tax shelters that are intended to help Canadians save for retirement. They are not investments, they are the shelter that you hold your investments such as stocks or bonds inside in a tax efficient manner.
How Are they Different?
The primary difference between RRSPs and TFSAs is how contributions and withdrawals are treated for tax purposes. Contributions made into an RRSP account are not taxable and can be used as deductions from your income for tax purposes, while contributions into an TFSA are made with “After tax dollars”. Both RRSPs and TFSAs allow your investments to grow and accrue interest and dividends without paying tax while held inside these shelters. When you withdraw funds from an RRSP the withdrawal is added to your personal income and taxed at your marginal tax rate. When you withdraw funds from an TFSA it is completely tax free.
an RRSP is much more of a true “retirement” account while a TFSA is a pure “investment account”
Another crucial difference between RRSPs and TFSAs is the age limit on when you can withdraw your investments. If you withdraw from your RRSP before the age of 55 you will be hit with a heavy penalty, while with a TFSA you can withdraw the funds at any time.
In this way, an RRSP is much more of a true “retirement” account while a TFSA is a pure “investment account”. I enjoy the flexibility that the TFSA provides me. If i want to sell off the investments held inside my TFSA to buy a rental property or any other investment opportunity, i’m free to do so. However, for many people without financial discipline, locking the funds inside an RRSP until they turn 55 is a great way to “Save them from themselves”. If the funds are locked in an RRSP they cannot be withdrawn to buy a boat or a new flat screen TV.
One final note on the differences between these accounts is the amount of money you can contribute on an annual basis. For the TFSA every Canadian can contribute a maximum of $5,500 per year, whole for the RRSP you can contribute up 18% of your taxable income up to a maximum of $26,320 in 2018.
Which is Better, RRSP or TFSA?
The only true answer to this question is “it depends”. If your workplace does not provide a pension and you are responsible for funding your entire retirement, I would focus on maxing out my RRSPs before worrying about a TFSA. As mentioned earlier, an RRSP prevents you from spending that money before retirement and ensures it will be there when you need it in retirement.
If you do have a workplace retirement plan or other means of funding your retirement then whether it’s best to invest through a TFSA or an RRSP comes down to 2 questions:
- Do I think I will have more taxable income today or when I retire?
- Do I have the Financial Discipline to not withdraw from my TFSA to buy things I don’t need
If you expect to have a large amount of taxable income in retirement, through pension plans, CPP, or rental income AND you have the financial discipline to not withdraw the funds and do something stupid with it, then a TFSA may be the way to go. Remember, anything you withdraw will be completely tax free, so you can withdraw large amount of funds from a TFSA without impacting your eligibility for OAS and other means tested social programs.
Personally, I contribute to both my RRSP and TFSA. In future posts I will expand upon different RRSP/TFSA strategies and how you can better leverage both tax shelters to maximize your wealth. For now, I hope this serves as an adequate breakdown of what RRSP’s and TFSA’s are and the key differences. Would love to hear any questions or comments in the comment section below.