Tax-free savings accounts (TFSAs) and registered retirement savings plans (RRSPs) are two types of accounts that you can use to save for the future. But how do they compare, and when should you use one over the over? Comparing the benefits and drawbacks of TFSAs and RRSPs can help you make the most of your savings.
What is a TFSA?
A TFSA is a government-registered account that allows you to set aside money throughout your lifetime for your savings goals, without paying any tax on the interest or investment income you earn.
As the name implies, TFSA withdrawals are tax-free, however, contributions are not tax-deductible. You can withdraw money from a TFSA at any time and spend those funds on anything — a wedding, vacation, new home, new car, etc. — or you can let your savings and investments earn compound interest tax-free to help fund your retirement.
You must be at least 18 years old and have a valid social insurance number (SIN) to open a TFSA. There are limits on how much you can invest in a TFSA each year, but your contribution room carries forward if you don’t use the full amount.
» See our picks: The best high-interest TFSAs in Canada
What is an RRSP?
An RRSP is a government-registered account that allows you to save for your retirement. RRSPs are tax-deferred accounts, which means you do not pay income taxes on your contributions or the earnings they generate while they are sheltered inside the account.
You do, however, need to pay taxes later when you withdraw the money. There are limitations as to how much you can contribute each year, and unused contribution room carries forward to future years.
There is no minimum age requirement to open an RRSP, but you can only contribute until the end of the year in which you turn 71. Anyone who works and pays taxes is eligible to open an RRSP in their name and the contributions are tax-deductible.
» See our picks: The best high-interest RRSPs in Canada
TFSA vs. RRSP similarities and differences
Sometimes RRSPs and TFSAs can be confusing. Both can be used to save for retirement, and both have detailed rules about contributions, withdrawals and tax implications.
Here’s a breakdown of the main similarities and differences between TFSA vs. RRSP to better understand how each type of account works.
A TFSA, on the other hand, can be used for anything you want. You can withdraw funds anytime and there’s no requirement to replace them.
The main purpose of an RRSP is to save for retirement. Programs like the Home Buyers’ Plan and Lifelong Learning Plan also allow you to put RRSP funds toward the purchase of your first home or education expenses, as long as you repay those funds within a certain amount of time.
To open a TFSA, you need to be at least 18 years old and have a SIN.
For starting an RRSP, you must be less than 71 years old, be a Canadian resident, earn an income and pay taxes.
Both TFSAs and RRSPs have contribution limits. If you are unable to max out your contributions for either your TFSA or your RRSP in a particular year, that’s OK. In both cases, the contribution room will be carried forward to future years.
For a TFSA, there is a set annual contribution limit — in 2023 it was $6,500 — that is added to any unused contributions you have leftover from previous years since you turned 18 or since 2009, whichever is more recent.
For an RRSP, the limit is 18% of your earned income from the previous year — up to a maximum set by the CRA each year, plus any unused contributions from past years. For the 2023 tax year, the RRSP contribution limit is $30,780.
When you withdraw from your TFSA, you get that contribution room back the following year.
However, once you withdraw funds from your RRSP, you lose that contribution room and the potential for compound growth that comes with it. Plus, you’ll have to pay a withholding tax on the amount withdrawn. This is partly why it’s best not to withdraw from your RRSP until retirement.
Both types of accounts shelter interest and investment income from tax.
TFSA contributions are not tax-deductible. The tradeoff, however, is that withdrawals from a TFSA are tax-free.
RRSP contributions are also tax-deductible, which means that they can help reduce the amount of tax you pay annually on your income.
However, withdrawals from an RRSP are taxable at your annual marginal tax rate in the year you make them. If you withdraw a lump sum from your RRSP, you’ll also pay a withholding tax.
TFSAs have no time limits; you can use them as long as you like.
You can contribute to an RRSP up until December 31 of the year in which you turn 71. After this point, you need to transfer the funds to a registered retirement income fund (RRIF) or an annuity, or withdraw the entire amount in a lump sum — though this last option is subject to withholding tax.
How do I choose between a TFSA vs. RRSP?
The type of account you choose will depend on your savings goals. You can also open both types of accounts to save for multiple goals at once.
RRSPs are designed for retirement savings. So, if you’re saving for something else, such as a dream vacation, a home or an emergency fund, a TFSA may be a better fit.
If your goal is to save for retirement, then an RRSP is a smart choice. However, a TFSA can also be used as a retirement vehicle. You may choose one or both investment options based on your specific goals, income and lifestyle.
People who earn a high income now and expect to have less income during retirement can benefit from the tax deferral provided by an RRSP, since they will likely be in a lower tax bracket when they withdraw the money. They may also find the other RRSP benefits appealing.
However, if your income is unpredictable or you prefer to keep more of your savings liquid, a TFSA might be a better idea in case you need to withdraw some of the funds early.
If you aren’t sure whether a TFSA or RRSP is right for your needs, it might be worth your time to speak to a professional financial advisor.
Frequently asked questions about RRSP and TFSA
Yes, you can and probably should have both types of registered accounts.
Yes, you can have multiple accounts at numerous financial institutions if you’d like, although it does make it more challenging to keep track of your finances. You need to make sure that the total amount you contribute to all TFSAs stays within your TFSA contribution limit, and do the same for your RRSPs.
For example, you can’t contribute the maximum annual amount to each TFSA account. Your contribution limit is the total amount you can contribute to all accounts of that type. Same goes for RRSPs.
The choice to contribute to a TFSA vs. RRSP depends on your goals, income, timing and other factors. For example, many financial experts recommend saving for retirement in an RRSP if you’re in any tax bracket above the lowest one, to take advantage of the tax deduction. If you’re in the lowest tax bracket (15%, which for the 2023 tax year applies to taxable income of $53,359 or less), you might not benefit as much from the tax deduction.
Another factor might be if your employer matches RRSP contributions, in which case contributing to your RRSP offers an advantage.
Alternatively, if you want easier access to your funds, a TFSA may be a better option.