TFSA or RRSP - Which one should you choose?

I know that Christmas is coming but soon after we will be looking at how we can save on our income tax and there will be many competing ads out there asking you to invest or save in a Tax-Free Saving Account or a Registered Retirement Savings Program.

When it comes to saving, the TFSA vs RRSP debate is always at the forefront. Many people are confused as to whether to choose the Registered Retirement Savings Plan (RRSP), Tax-Free Savings Account (TFSA) or a combo of both to put money away for the future. Regardless of whether you choose the RRSP or TFSA (or make use of both!), one of the best things you can do is invest consistently.

Both the TFSA and RRSP are investment vehicles that reduce taxes on investment income but depending on your circumstances, one might better for your money than the other. The TFSA is more flexible and offers a better tax benefit than the RRSP, but doesn’t have as high contribution room. The RRSP will probably let you set aside more, but has stricter rules around when you can withdraw your money, and what for. Ultimately, everyone should aim to have both an RRSP and a TFSA and spread out the savings across both accounts. Two of the most common investment questions are: “What’s the difference between an RRSP and TFSA?” and “Which one should I choose?”

Despite their names, neither the RRSP or TFSA have to be a savings account. You can and should hold a variety of investments in your accounts such as GICs, mutual funds, stocks, bonds, and ETFs. Both of these accounts should be more appropriately named “Tax-Free Investment Account” and “Registered Retirement Investment Plan” because investing is really the best way to unlock the power for these accounts.

The real difference between the RRSP and TFSA come down to their contribution limits and withdrawal restrictions, as well as how and when you pay taxes at these events.

The differences between a Registered Retirement Savings Plan (RRSP) and a Tax-Free Savings Account (TFSA) are outlined below. Which one you should choose depends on a few factors: your current tax rate, your reason for saving, and your future tax rate.

An RRSP is mainly intended for retirement savings.

·       Annual contributions are tax-deductible.

·       Your contribution limit is based on earned income.

·       Your contribution room begins at whatever age you begin working and filing a tax return.

·       The contribution limit for 2019 is 18% of the earned income reported on your 2018 tax return, up to a maximum of $26,500.

·       If you don’t contribute to an RRSP, your contribution room accumulates and you can contribute even larger amounts in the future.

The TFSA was introduced by the federal government in 2009, as a way for anyone 18 or older to set money aside tax-free throughout their lifetime.

·       Annual contribution limits amounts have varied over the years.

·       From 2009 to 2012, the maximum for each year was $5,000.

·       From 2013 to 2014, the amount increased to $5,500 for each year.

·       In 2015, the amount increased again to $10,000.

·       From 2016 to 2018, the amount decreased to $5,500 for each year.

·       In 2019, the amount increased to $6,000.

·       TFSA contributions are not tax-deductible and contribution room accumulates if unused. Anyone who was 18 or older in 2009, and has not yet contributed, will have $63,500 of contribution room available in 2019.

The chart below shows how different tax rates during your working years and retirement years can affect your decision to invest in an RRSP or a TFSA today, and the after-tax value after 20 years.