Investing » TFSA

TFSA vs RRSP: Why not do both?

Back in 2009, the Tax Free Savings Account (TFSA) was introduced to Canadians.   Since that time, TFSAs have grown in popularity and as a result, there are lots of great debates over the RRSP and the TFSA. Let’s take a deeper dive into this debate to help you make good financial decision:

RRSPs give you an immediate tax deduction

The most attractive feature of the RRSP is the immediate tax savings you get when you put money into the RRSP.  The value of this tax break is determined by the marginal tax rate that you are in.  This short term tax gain is offset by future tax pain when you take the money out of the RRSP.  When you take money out, you have to pay tax based on your marginal tax rate at the time you take the money out (not based on the tax rate when you originally put the money in).  Any growth inside the RRSP, grows tax deferred but eventually gets taxed when withdrawn from the RRSP.

Related article:  Making the right RRSP decision with one formula

Tax Free savings accounts give Tax Free growth

Unlike the RRSP, there is no immediate tax deduction when you put money into the TFSA but the big appeal with the TFSA is there is no tax paid when you take the money out.  If you think about it, that’s not such a big benefit because the same thing happens with your bank account or any non-RRSP savings or investments with regards to your capital or principle).  The big appeal with TFSAs is actually the TAX FREE growth on your investments. You dont pay tax on any of the growth inside a TFSA.  That is a big benefit.

Related article:  TFSA Basics: contributions and withdrawals

TFSA vs RRSP: Comparing the Tax

So when you look at the different tax treatments of the RRSP and the TFSA, tax is one of the mathematical ways to compare the two accounts:

 Non-RegTFSARRSP
Before tax income$1000$1000$1000
Income tax (30%)$300$300$0
After tax contribution$700$700$1000
Value after 25 years (6% growth)$3004$3004$4292
Income tax at withdrawal (30%)$601$0$1287
Net withdrawal after tax$2403$3004$3004

In this example, the end result is the TFSA and RRSP are very similar when the marginal tax rate is the same (30% in this example) when the money goes in and also when the money is withdrawn. Note:  The tax calculated under the non-RRSP column assumes no tax efficiencies. Tax could be lower if dividend or capital gain is taken into account.

In the following example, there is a mathematical edge to the RRSP if the marginal tax rate at the time of withdrawal is less than the marginal tax rate at the time of contribution:

 Non-RegTFSARRSP
Before tax income$1000$1000$1000
Income tax (30%)$300$300$0
After tax contribution$700$700$1000
Value after 25 years (6% growth)$3004$3004$4292
Income tax at withdrawal (25%)$501$0$1073
Net withdrawal after tax$2503$3004$3219

If on the other hand, the marginal tax rate at the time of withdrawal is greater than the marginal tax rate at the time of contribution, then the TFSA has the advantage:

 Non-RegTFSARRSP
Before tax income$1000$1000$1000
Income tax (30%)$300$300$0
After tax contribution$700$700$1000
Value after 25 years (6% growth)$3004$3004$4292
Income tax at withdrawal (35%)$701$0$1502
Net withdrawal after tax$2303$3004$2790

Remember that every example you find on the web is based on a set of assumptions for illustrative reasons only.  It’s important to apply the process to your own circumstances and numbers using your own assumptions that you think are best suited for you.

Other important factors

While tax creates an opportunity to compare the different accounts mathematically, there are other issues that will impact your decision in choosing RRSP vs TFSA

Saving to spend

If you are saving to spend money in the near or mid term like saving for a car or a kitchen renovation or maybe for a vacation, I think we can all agree that the TFSA is a better option because using the money does not trigger tax.  However, putting money into a TFSA and then taking out on a regular basis kind of defeats the real benefit of a TFSA and that is the long term TAX FREE growth.  Constantly taking money out of the TFSA can be a big hurdle to growth. If you think about it, you be better off using a savings account outside of a TFSA to accomplish the same thing (especially when interest rates are really low).

Emergency Funds

Most people will agree that a TFSA, conceptually, can be a great place for emergency money.  However, you can also argue that an emergency fund should not only be readily accessible but also safe.  Putting safe investments with lower returns can also negate the true benefit of Tax Free growth so non-RRSP savings may be a better alternative for emergency funds over the TFSA.  That way you can use your TFSA to invest more for growth.

Related article:  Investing options for the TFSA

Saving for your first home or for education

While the TFSA and the non-RRSP are logical ways to save for a home or for education, the RRSP does offer 2 opportunities to withdraw money through the First Time home Buyers Plan and the Lifelong learning Plan

Saving for retirement

If you are saving for retirement or for the longer term, the math presented earlier can be pretty helpful in making that decision.  Understanding the differences in tax treatment is quite important in the debate.  

It’s not mutually exclusive

One of the problems with the outcome of the TFSA or RRSP debate is it seems like people have to make the choice between one or the other which really is not the case. Both the TFSA and the RRSP have merits.  Is one really better than the other?

Both the TFSA and the RRSP have strong financial benefits.  My wife is a dietitian and if I were to ask her which is better to eat, carrots or broccoli, she would tell me “they are both good for you, you should have them both in your diet.” 

She could get really analytical about the nutritional content of each but in the end, they are both good.  I would say the same about TFSAs and RRSPs: both are good for you. We can analyze the tax merits one way or another but lets face it, they both have strong merits.  One way to invest in both the RRSP and the TFSA is to invest in the RRSPs first and then use the tax refund put it into the TFSA.  Here’s an example:

Let’s say you have $5,000 to invest. You could put the entire $5000 into the TFSA and be really happy about a liquid tax-free account.

On the other hand, you could put $5000 to the RRSP which will generate a tax savings based on your marginal tax rate. If we assume a marginal tax rate of 35%, that translates to a tax savings of $1750. You could then take the $1750 of tax savings and put that into an investment in the TFSA.

Essentially, you now got $6750 of use out of $5000. Let the government contribute to your TFSA so you can get more money working for you.

Not sure which is better, start with the TFSA

Many people really like the flexibility you have in the TFSA. If you put money into the RRSP, you can’t get the money out without tax consequences. That also means you can’t move the money to the TFSA without paying the tax if you decide later, that was a better course of action.

On the other hand, if you put the money into the TFSA, you can always move the money to the RRSP later without tax consequences. As many of the experts above have pointed out, this may be ideal when you are younger and just starting out or in a lower tax bracket.

On the flip side, I like the TFSA a lot and I think they have great merit but sometimes, I think they are too easy to access.  If you are not very disciplined, sometimes putting money into RRSPs help prevent you from taking it out in the future.

Remember FREE MONEY

If you have access to a Group RRSP through work and the employer matches contributions, I call this FREE MONEY.  In this case, always choose the RRSP before the TFSA.

Related article:  Group RRSPs:  Are you missing out on Free Money?

“Better” is personal

All financial planning is personal. Just because the average Jane thinks TFSAs are better than RRSPs does mean that applies universally to everyone, especially you. Just because I say I like the RRSPs better for me, does not mean you should blindly follow my personal strategy. Here’s three rules of thumb to help you analyze your personal situation to make good decisions

    1. Use my one formula approach. If your marginal tax rate at the time of contribution is greater than your marginal tax rate at the time of withdrawal, then the RRSP makes sense.
    2. If you are not sure which way to go, the safer course of action is to buy the TFSA because it gives you the most flexibility in the future.
    3. If you can, do both. They are both great financial accounts so the ideal strategy is to have both. One way to do that is to buy the RRSPs first and get the government to put money into the TFSA for you.

Final thoughts on the RRSP vs TFSA debate

I will finish off here outlining some of the other rules of the RRSP and TFSA which may be relevant when choosing between RRSPs and TFSAs

    • For the TFSA, you have to be over 18 to accumulate contribution room. With RRSPs, you start to accumulate contribution room as soon as you start working and file a tax return.
    • TFSA limits are set annually by the government. Everyone has the same limit.  RRSP limits are based on your previous years income so everyone can contribute different amounts to the RRSP.
    • If you don’t contribute into a TFSA, you do not lose your contribution room. It carries forward into the future.  The same applies to your RRSP.  Both your RRSP and TFSA limits are tracked by CRA.
    • Once you reach age 71, you can no longer contribute to a RRSP unless you have a younger spouse and contribute to the spouse’s Spousal RRSP. There is no upper age limit for TFSA.  My 91 year old father still contributes to a TFSA.
    • Both the TFSA and the RRSP offer the same options for investments. You can invest in savings, GICs, bonds, mutual funds, Exchange Traded Funds, stocks, etc.
    • If you take money out of a TFSA, you can put it back in but you must wait until the next calendar year to do so. If you take money out of your RRSP, you cannot replace it unless you have unused RRSP contribution room.  Any money you put into a RRSP uses up your contribution room.
    • TFSA investments grow TAX FREE. RRSP investments grow TAX DEFERRED.
    • For both the RRSP and the TFSA you can name a beneficiary. If you have a spouse, there are tax benefits to naming your spouse as a beneficiary on the RRSP and as a Successor Annuitant on the TFSA.

Comments

  1. Canadian Capitalist

    “If you can, do both. They are both great financial accounts so the ideal strategy is to have both.”

    True dat. If either account is too successful, it is a very nice problem to have!

    Thanks for the mention!

  2. youngandthrifty

    Love the TFSA vs RRSP round up!
    Thanks for including me.

    Glad to put an end to this debate 😉

    Both= good!

    • R N

      RRSP better if the lifespan is longer. However, assuming no carry forward to spouse on death, the estate gets taxed at a very high rate(maybe >50%) if all accumulated amount is taxed at one go. At least, TFSA is better for estate purposes as it’s totally tax-free. Further, TFSA tax payment is over the years and RRSP tax is at one lumpsum. If longevity isn’t certain, people should opt for TFSA.

  3. Win

    Jim, great post! I love the idea of getting the government to invest in the TFSA for us.

    I have a question though, I have $5000 in the TFSA already (because I’m young and I wasn’t sure what to do with the money.) If I move this money into RRSP, isn’t this $5000 already after-tax, which means I don’t benefit from the tax-deferring effect of the RRSP?

    • Steve

      Any money put into an RRSP can be used as a tax deduction, TFSA’s included.

  4. RICARDO

    Yes, if you are just starting out, do both to the max.
    Having said that, there are not that many (1%) who can afford to max out both especially when they are starting out.
    And if you started young enough and you earn that six figure salary (so you can truely put the max in) then there may come a time when it is not that wise to keep building your RRSP for the simple reason that it is taxable income when withdrawn. In those cases you may want to consider a non-registered account paying dividends that are taxed at a lesser rate that withdrawals from a RIF.
    Different strokes for different folks and especially for different portfolio values.

    RICARDO

  5. KC

    I’m in the unique situation where I can also contribute to the RDSP, so I contribute enough to get the government matching program, use the RRSP to take advantage of the employer’s matching program which I then use the refund and put that into the TFSA.

  6. HeyFlo

    The more important question, which is rarely addressed in these stories… is what to do with the money once it has been contributed to either of these accounts. I know many people with TFSA accounts with nothing but ‘high interest’ savings… high being less than 1%. People are discouraged when the money in registered accounts is not growing. The stories emphasize tax savings, but it’s the follow up with intelligent investing for decent returns and manageable risk that needs most attention.

  7. Dividend Earner

    I don’t think the debate will ever go away … and unfortunately, forecasting your tax bracket 40 years later requires a very good understanding of oneself.

    I think we should start offering suggestions around TFSA and RRSP based on the type of jobs people have. That should offer a decent guideline and take into account pension plans.
    – Teacher
    – City Employee
    – Automotive

    – Lawyers
    – Engineers

    For the most part, it’s really hard to change work after 20+ years so once you are in, you pretty much are doing it until retirement. Those jobs have estimated income that are accessible (schools have it to show students and income relationship).

    People have a hard time looking at numbers and extrapolating but I don’t think it’s too hard to paint the picture based on the type of job and expenses. If the person looking at it realize they don’t invest enough, then they can question themselves.

    Then there is the strategy of just buying TFSA for the first 10 years maybe until you reach the top tax bracket and then in one swoosh, you transfer all your TFSA over to your RRSP, get the tax refund and put it in your TFSA or RRSP … Which do you do?

    Time and time again, I realize most people cannot do the math and forecasting so they need it spelled out according to their life situation. The only way I can think of is to use the job category to show the best optimal path because it defines the income.

  8. Dan Galarne

    no brainner for me, here is an exemple….max your RRSP and you put the tax return to an TFSA. Even if 40 years down the road you are still at the same tax bracket ( I doubt it) you still used 40 years worth of tax money to pay yourself in a TFSA. With split income on retirement your tax level will be very low on your RRSP and even after that, there is going to be a big chunk of money left in RRSP as well as in the TFSA. Trouble is where are we going to vacation LOL

  9. Bert

    I consider my level of financial acumen to be low so please forgive my naivety or compete lack of insight here. It seems that the key is to use the tax rebate of any RRSP contribution as a TFSA contribution otherwise a TFSA may be better than RRSP. I am retired, age 69, but would like to,advise my sons so please point outs any flaws in my thinking.

    I did some rough calculations based on. $2000 RRSP contribution. That will garner a $700 (35%) refund. If that $2000 is invested in a TFSA for 35 years at an average return of 4% it will be worth $7900 and wil be tax free. If however it is in an RRSP that $7900 will be taxable and at a 20% rate means a tax of $1578 or about double the initial refund. If however that initial refund is invested in a TFSA in 35 years it will be worth about $2700. More than enough to pay the tax from the RRSP .

    Am I missing something here?

    • Greg

      You are missing an important thing:
      The money you are doing in your RRSP is not taxable unless you want to withdraw it.
      So your $1578 deduction does not exist.
      You will be making the same money in both TFSA & RRSP.
      RRSP main advantage is the the 30% tax return.

  10. Dan Galarne

    Bert, you are 1/2 right but push your calculations a step further. $2000. @ 4% = $7892. in 35 years ( RRSP OR TFSA if invested in the same funds). Both will return the same , $7892.minus $1578 in tax leaves you with $6314. What you forgot is that $700. tax return that you invested in TFSA will give you $2762. in 35 years. So add $6314. + $2762. = $9076.therefore about $1184. more for the same investment. Multiply this by 35 if you invest the same over the 35 years and you end up $$$$$. more than just going with the straight TFSA. Hope this makes sense

    • Bert Finster

      Thanks. Dan. Yes I follow, I think we said the same think in different ways. 🙂 . As I said the key is to invest that $700 refund in a TFSA to get the $2762 (rounded of all the numbers) which more than pays for the tax on the RRSP.

      However, I do not get your 2nd last sentence “Multiply this by 35 if you invest the same over the 35 years and you end up $$$$$ ” You already calculated the 35 yr return on the $2000 initial investment and also the $700 refund. What else are you talking of investing for 35 years?

      • Dan

        You repeat the same investment every year for 35 years. Of course everything would be prorated (all subsequent investment will return less as they won’t the same amount of time to grow) giving that we always play with the same numbers after 35 years (or even one year) you are better to do it this way. Another example is you dont pay tax now on the 2000 so the full amount grow (the 2000 in TFSA would cost you $2700. after tax. The return is found not taxable money that goes to the TFSA

  11. Mubbin Jamal

    Wonderful article. Upon retirement, is it better to withdraw from TFSA first, or from RRSP first? Thanks very much

  12. Aaron Jones

    The article should also mention the potential impact that RRSP/RRIF withdrawals can have on the OAS clawback (~$79,000 for 2020) vs. TFSA. This is particularly important for people with excellent defined benefit plans.

  13. Janet Oakes

    Great article. Nice to have the comparison made so clearly. Thanks.

  14. Bill G

    The non-registered tax seems to be based on interested-bearing investments only? i’d argue that the best use for non-registered accounts is equity. The end result is the tax on capital gains is half of what you have here. There’s also the possibility of hold dividend-bearing equities in your non-registered account to get even further tax benefits. I don’t the think your comparison paints a complete picture of the options.

    I do agree to max out your TFSA then RRSP but one shouldn’t be avoiding non-registered options because of the fear of taxes owing.

  15. CURTIS ENNS

    Interesting discussion!

    Non Reg account.
    In the case of a pure equity investor, growth would occur, mostly tax free as a result
    of share value appreciation until sale of shares, at which time one would pay tax on 50%
    of the capital gain. This would be 1/2 the tax compared to the RRSP.
    (of course dividends would be taxed annually).
    I believe this is missing in the comparison.

  16. David Marecek

    Great comparison and helpful for planning. As per other articles on geographical asset allocations (ie outside Canada investments), the difference between the two re country asset allocation is that RRSP do not have foreign income tax withheld(tax treaty protected) and TFSA do have foreign tax withheld(not recognized by foreign countries as protected).

  17. Mary

    My employer did not offer the option of a TFSA. As a result, to take advantage of the company match for my RPP, I had no choice but to invest in an RRSP. Today, I would handle this a bit differently. I would take my match, but make sure the maximum annual contribution was made to a TFSA. This would require a little extra planning (as payroll deductions are so easy). But it would insure more of my retirement income could be accessed from a non taxable source. I explain this as I believe many, during their busy working years, simply don’t consider how important this decision will be down the road.

  18. Cam Maxwell

    Just a quick question on the Non-Reg net withdrawal. Shouldn’t the income tax only be 288.00 at the 25% tax rate.
    3004-700 = 2304 capital gain
    2304 x 50% inclusion rate = 1152.00 taxable capital gain
    1152.00 x 25% tax rate =288.00 total tax

    Same applies to the 30% tax rate example

Leave a reply

Your email address will not be published. Required fields are marked*