RRSP vs. TFSA: Which Savings Plan Is Right For You?

Posted on January 28, 2015 and updated February 3, 2015 in Life Insurance Canada News 6 min read

TFSA vs RRSP Savings Plan

A Registered Retirement Savings Plan (RRSP) and a Tax-Free Savings Account (TFSA) are the two best choices for many Canadians when it comes to setting aside savings and investing some of their current income for the future. Yet, the question remains, among RRSPs and TFSAs, which savings plan is better?

There isn’t a universal answer to that question, as both RRSPs and TFSAs offer their own advantages and disadvantages. While some people in a certain income and age bracket will be better off using TFSAs, others will find that investing in a RRSP is the best way to go.

Let’s take a quick look at how RRSPs and TFSAs compare against each other.

Investing in RRSPs and TFSAs

When it comes to the type of investments allowed under each plan, both RRSPs and TFSAs don’t really differ from one another. Savings accounts, Guaranteed Investment Certificates (GICs), stocks, bonds and mutual funds are all eligible investments for both RRSPs and TFSAs.
Speaking of mutual funds, it’s also worth noting that many insurance companies will sell you segregated funds rather than mutual funds. These segregated funds are also eligible to be put into RRSPs and TFSAs. While segregated funds are similar to mutual funds in many ways, they also have several exclusive benefits. Some of these advantages include having a maturity guarantee of 75% of your principle investment, resetting privileges to lock in growth and protection of assets from creditors.

While RRSPs and TFSAs both have similar types of eligible investments, that’s where most of the similarities between the two savings plans end. From here on out, they go in different directions.

Contributing to RRSPs and TFSAs

Let’s start with how you contribute to each plan. Canadians earning less than $130,000 a year can contribute up to 18% of their annual income to their RRSP. Anyone earning over that amount can contribute a maximum of $24,270 (2014 figure) annually to their plan. It’s also very important to note that you can’t make any more contributions to your RRSP once you pass the age of 71.

Contributing to a TFSA works very differently. You can only contribute a maximum of $5500 (2014 figure) to this plan annually, regardless of your income. On the other hand, there are no age limits and you may keep contributing up to the yearly limit indefinitely.

Taxing Your RRSP or TFSA

RRSPs and TFSAs are also taxed differently. Your RRSP contributions are tax deductible and you will receive a tax refund for them annually. That refund can go towards your RRSP contribution for the upcoming year. You can even take advantage of this tax deductible status and hold investments like USD stocks in your RRSP without paying any of the taxes you would normally be charged if you were holding this stock in your portfolio outside of a RRSP. All of this seems like a good deal right? Unfortunately, there is a downside. While your RRSP contributions are tax deductible, any money you take out of this account in the future will be taxed accordingly as part of your income. This means that if you have a decent pension and draw additional money from your RRSP, you could be heavily taxed during your retirement years.

Unlike RRSPs, TFSA contributions are not tax deductible. This means that any contributions that you make to your TFSA will be taxed just like the rest of your income. On the flip side, the money in your TFSA isn’t taxed and you can withdraw it entirely tax-free. This tax-free status also applies to any additional money you may earn from your invested money in a TFSA. For example, if you earn $1000 a year based off your invested money in a TFSA, that $1000 would be not be considered as “income” and won’t be taxed.

Withdrawing from a TFSA and RRSP

This brings us to the next major difference between these two plans: withdrawing money. TFSAs will let you withdraw your money at any time. The amount of money you withdraw in one year will be added to your contribution limit for the next year. For example, if you withdrew $5000 in 2013, you would be able to contribute an extra $5000 toward your TFSA in 2014 alongside your regular contribution.

RRSPs are much more restrictive when it comes to withdrawing money from your account before you reach your retirement years. Typically, you are only allowed to prematurely withdraw funds from your RRSP if you’re purchasing a house or paying for education. Any withdrawn money from your RRSP has to be repaid in yearly installments.

Conclusion

Well, that’s it for most of the major similarities and differences between RRSPs and TFSAs. Like mentioned earlier, there is no easy answer for which plan is universally better for you. Both of them provide their own unique advantages and benefits. If you have a large income, then strongly consider contributing to both of these great money saving plans.

If you have a lower income and can only choose one plan, then consider contributing to a TFSA. Because you have a lower income, you likely won’t be able to take advantage of the RRSP’s tax deductible feature anyway. Having the flexibility to withdraw your money from your TFSA at any time could also come in handy if you’re in need of emergency funds or have short-term goals you want to accomplish.

If you’re part of a higher income bracket, then consider contributing to a RRSP before the TFSA (although you should definitely be thinking about contributing to both plans if you have the funds). This will allow you to make a large yearly contribution to your RRSP and reduce your total income tax at the same time. You can then use those tax savings to invest in a TFSA if you wish. Because of your higher income, you’re also much less likely to require emergency access to the funds in your RRSP account.

Again, there’s no right or wrong answer here. At the end of the day, it’s important for you to do your research and figure out which savings plan here fits your own personal needs. Just remember though, its best that you start contributing to these plans as early as possible during your professional life in order to reap the maximum benefits.

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