RRSPs vs. TFSAs: A Breakdown

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Sometimes when I meet a client and ask what they have for savings, they’ll say they have a TFSA and some mutual funds. Then I ask them what their TFSA is invested in, and I get a blank look. This is totally common in that many first-time investors had a TFSA opened at their bank because someone suggested it (Dad, teller, online ad), but totally abnormal in that TFSAs and mutual funds are not mutually exclusive. Tax-Free Savings Accounts and Registered Retirement Savings Plans are what we call Investment Vehicles. They are the car model you’ve decided to go with. Mutual funds, savings bonds, cash: all of these can be the drivers of your vehicle (aka: the money that you put in your vehicle still needs a driver). I don’t want to get into investment options yet, because I want you to understand the difference between two of the biggest savings vehicles we have available as investors: RRSPs and TFSAs. These savings vehicles are what we call registered, in that they are government-created vehicles that have tax advantages. The growth of money inside of non-registered investments is taxed every year. I made this table below to answer some quick questions and to compare the two registered vehicles. 

Feature	TFSA	RRSP
What kind of dollars are contributed?	After-Tax dollars go into a TFSA (aka you’re not getting a return at tax time)	Pre-Tax dollars go into an RRSP (aka you could get a return at tax time)
When I withdraw, how is it taxed?	None of your original contributions or any growth will be taxed at all, because they were taxed before they were contributed.	100% of what you pull out (original contributions plus growth) will be taxed as income. But remember, you haven’t paid taxes on any of this yet.
What can I invest in inside this account?	Cash, GICs, bonds, stocks, mutual funds (same!)	Cash, GICs, bonds, stocks, mutual funds (same!)
How much can I contribute?	Contribution room starts accumulating when you’re 18 (around $5000/year). This question would require some investigation!	18% of your previous year’s income, plus any carry-forward from years’ previous (there are maximums. This year it’s $26,230). This question would require some investigation!

To help you further understand which one might be right for you, I’ve made this handy little chart! Often, clients will have both vehicles because they have a few different goals in mind. To use the chart below correctly, focus on one goal at a time.

RRSPs vs. TFSAs

1.      For the first result to the left, I’ve indicated that if you were saving for the short-term, you may want to consider a TFSA. Taking money out of a TFSA doesn’t trigger taxes, and none of the potential growth from investments is taxed either, which means that if you wanted to take out $2,000 for a vacation, you would get $2,000 in your pocket. Alternatively, with an RRSP, you would end up with $1,343 (having paid $656 in taxes at an income of $45,000 annually) or withdraw $3,025 to net $2,000.

2.      For the second result, I’ve indicated that if you’re making more now than you hope to in retirement, you may want to consider an RRSP. Because all withdrawals from RRSPs are taxed as income, and because you’ll be making less annually in retirement, you’ll be in a lower tax bracket. So, withdrawing $2,000 while making $60,000 will cost you ~$706, vs when you’re making $40,000 annually in retirement, withdrawing $2,000 will cost you ~$541. What this means is that in contributing years while making $60,000 annually, you’ll receive the higher tax bracket percentage back (so, $706) as a tax return but when you withdraw it later on in life while making an income of $40,000 you’ll only pay $541, which means you’ve saved $165 in this example.

3.      For the opposite reason above, I would potentially recommend a TFSA if you’re currently making less now than you anticipate making in retirement. RRSPs exist to help save on taxes overall. If you had an RRSP in the case of less-now more-later, you would end up paying MORE in taxes overall. Ew!

4.      The first yellow box is to address potential home buyers’ concerns. If you’re saving up for the down payment on your first home, you can utilize the First Time Home Buyer’s Plan which allows you to access your RRSP savings without paying taxes (repayment time limits exist). You should definitely look into this before you decide how you want to start saving for your home!

5.      The last yellow box is a toss-up between an RRSP and TFSA depending on the saver. Perhaps you want to save for retirement in theory but you’re not sure if you’ll need the money for something else along the way. Perhaps you’re saving up to take a year off work. Perhaps you’re paying for a child’s education in a decade or two (in that case, an Registered Education Savings Plan needs to be discussed!).

This chart is by no means a flawless solve-all for savings. We also haven’t gotten into the finer details of risk tolerance, investment style, or fees. That being said, it’s a great start to help you see how you can be making decisions right now to impact your economic future.

Peace, love and WEALTH,

Rachael