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Insights & advice

What’s the difference between a TFSA and an RRSP?

January 2023 – 15 min read

Key takeaways

  • RRSPs are used mostly to save for retirement, but you can withdraw money for your education or to buy your first home

  • TFSAs are mostly used to save for mid and short-term goals like a vacation or vehicle

  • There are some common misconceptions about RRSPs and TFSAs

  • There are things to consider when choosing between an RRSP and a TFSA

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What’s in this article?

What’s an RRSP?

A registered retirement savings plan (RRSP) is an investing and retirement savings account registered with the Canada Revenue Agency (CRA) that provides Canadians benefits to save for retirement.  

Here’s how you can benefit from an RRSP:

  • Your RRSP contributions may be deducted from your income resulting in a lower taxable income.
  • You don’t pay tax on the income earned in an RRSP.
  • Once you retire and receive payments from a registered retirement income fund (RRIF) or annuity, your marginal tax rate may be lower because your earned income may be less at that time.
  • You or your spouse/common-law partner can contribute to your RRSP.

RRSPs are for more than retirement

From borrowing money for a down payment on your first home to furthering your education, you can do more with an RRSP than just save for retirement.

What’s a TFSA?

A tax-free savings account (TFSA) isn’t a typical savings account. It’s versatile, so you can use it to save for a more immediate goal, like saving for a new car or a trip, but you can also use it to save for your retirement. 

Here’s how you can benefit from a TFSA:

  • You don’t pay tax on any Income earned in a TFSA or on money you withdraw.
  • There’s no contribution deadline, which means you can contribute to a TFSA at any time. Any unused contribution room is carried forward on January 1 each year.
  • If you withdraw money from a TFSA, you can recontribute it to your account (but you must wait until after Jan. 1 of the following year to do so).
  • You can put your TFSA funds towards many large expenses, including academic courses, a down payment on a home and retirement expenses.
  • Your spouse can give you money to contribute to a TFSA without attribution of income.

Do you need a TFSA or an RRSP?

At the end of the day a TFSA and an RRSP both help you do the same thing – allow you to save money for the future. But they do it in different ways, so depending on your circumstances, having both can help you achieve your goals.
RRSP
TFSA

How do you start one?
You earned an income and filed your income taxes for the previous year
Automatically if you’re 18 or older, have a valid social insurance number and are a Canadian resident

How long can you contribute?

Dec. 31 of the year you turn 71

For life

What’s the contribution deadline?

March 1, 2023 to claim a deduction for the previous year
Not applicable as contributions aren’t deductible

What’s the contribution limit?

The smaller amount of 18% of your earned income last year or 2022’s annual limit of $29,210 plus any unused carry-forward contribution room, less any pension adjustments

$6,500 for 2023, plus any withdrawals in a previous year and any unused contribution room carried forward from the previous year

What happens if you withdraw money?

Contribution room is permanently lost
Never lose contribution room. It’s re-added on Jan. 1 of the following year

What are the upfront tax advantages?

Lower your taxable income for the current year

None because contributions are made with after-tax income

What are the future tax advantages?

Any income earned in your RRSP is usually free from tax as long as it stays in the plan.

Every dollar you withdraw is taxed at your marginal tax rate, which is usually lower when you’re retired.

You generally won’t pay tax on any income earned in the account or the money you withdraw.

There aren’t any tax consequences if you need to use your savings for emergencies or short-term expenses.

Withdrawals aren’t considered income, so this money isn’t included when the government calculates benefits like Old Age Security, Guaranteed Income Supplement, GST/HST credits and other credits/benefits like the Age Credit.

Bottom line
Can provide greater short and long-term tax benefits but is less flexible because you have to pay income taxes on withdrawals
Doesn’t offer as many tax benefits, but is much more flexible because there are no tax consequences for withdrawals

Common misconceptions about RRSPs and TFSAs

RRSPs are pointless if you have to pay tax once retired

Not necessarily. As you build your savings in an RRSP, you don’t pay taxes on that growth until it’s withdrawn. So, by the time you start withdrawing a steady amount from your RRSP, you’ll be retired and may no longer be receiving an income. That means your tax rates may be lower on withdrawals, so the money that you’ve saved for years in an RRSP can still help you live out your dream retirement. 

Plus, each year you contribute to your RRSP, you can claim an income tax deduction for the amount you’ve contributed. So, while you’ll pay tax on withdrawals during retirement, you can save on your taxes in the years you contribute. 

RRSPs are only for retirement

The money that you invest in an RRSP can go towards more than your retirement. Here are some other big life events that you can put your RRSP funds towards:

  • Financing a home: You can borrow money from your RRSP for a down payment on your first home under the government’s Home Buyers’ Plan. You don’t have to pay tax on this money, so long as you pay it back within 15 years after it’s withdrawn.
  • Saving for an education: You can borrow money from your RRSP to pay for full-time education or training for yourself or your spouse under the government’s Lifelong Learning Plan. You don’t have to pay tax on this money, so long as you pay it back over a period of 10 years.

You should only put money in an RRSP right before the annual deadline

Every year, the deadline to contribute to your RRSP is in the first 60 days of the year. However, you can contribute up to the maximum amount at any point throughout the year, which can help you save at a steady rate. If contributed early in the year, you can get the benefit of compound interest that will be reinvested – the money grows for almost a full additional year. 

If you contribute any funds after the March 1 deadline, those contributions will result in a tax receipt for the following year. For example, if you contribute on April 1, 2023, those contributions will be on your 2023 tax receipt. However, if you contribute on February 1, 2023, (or any time before March 1, 2023), your contributions will result in a 2022 tax receipt.

How to choose between an RRSP or TFSA

Many investors will end up investing in both RRSPs and TFSAs. However, here are some things to consider about when to invest in each. 

  • Income

    Generally, if you make more than $50,000, you should invest in RRSPs because the money creates a tax deduction that helps reduce the income tax you’ll pay. If you make less than $50,000, the RRSP tax deduction is less important because after claiming basic tax deduction, you probably won’t be paying much income tax. Therefore, you should invest in TFSAs.

  • When you’ll use the money

    RRSPs are for retirement, a long-term goal. TFSAs can be for retirement as well, but are also used for short and medium-term goals such as a vacation, vehicle or emergency fund.

  • You have a group plan

    If you receive a matching contribution from your employer for a group RRSP, then you should try and maximize that if you can.

  • You’re buying your first home or funding your education

    Contribute to an RRSP due to the availability of the Home Buyers’ Plan and the Lifelong Learning Plan.

  • Your marginal tax rate when you expect to use the money

    You should consider RRSP contributions when your current marginal tax rate is higher than when you’ll use the savings as income (retirement). You should contribute to a TFSA when your marginal tax rate is lower than when you expect to use the money.

The information provided is based on current laws, regulations and other rules applicable to Canadian residents. It is accurate to the best of our knowledge as of the date of publication. Rules and their interpretation may change, affecting the accuracy of the information. The information provided is general in nature, and should not be relied upon as a substitute for advice in any specific situation. For specific situations, advice should be obtained from the appropriate legal, accounting, tax or other professional advisors.

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