RRSPs and TFSAs are similar because they both provide incentives for Canadians to save and invest, but their differences will likely lead you to one or the other.
The big difference
The biggest difference between an RRSP and TFSA is when you pay tax. RRSP contributions are called “before tax” money because those investments are tax deductible. This means that you’ll have to pay tax when you withdraw it—not a good thing if your income tax rate is high at that time.
In comparison, TFSA contributions are called “after tax” money because those contributions are not tax deductible. As such, you do not pay tax on withdrawals.
Two simple rules
If the amount of tax you’ll need to pay is your only concern, follow these general guidelines:
- If your income tax rate is likely to be higher when you make withdrawals, use a TFSA.
- If your income tax rate is likely to be lower when you make withdrawals (i.e. when you retire), then choose an RRSP.
The pros and cons of flexibility
Although you should definitely consider taxes when making your decision, don’t forget about other factors—like your saving and spending habits.
Because you don’t have to pay tax when you withdraw from your TFSA, it’s easier to access those funds at any time, for any reason. As such, TFSAs are a great option if you are unsure when you will need to use your savings.
But if you are committed to saving for retirement and want to avoid the temptation of accessing those savings earlier, an RRSP is the wise choice. The tax consequences of withdrawing RRSP funds can be significant, so it’s always best to leave those savings untouched until you’ve retired. For this reason, the inflexibility of an RRSP might be better for you even if the numbers point to a TFSA.
The types of accounts in which you hold your investments can be just as important as the investments themselves. Get expert advice at your local branch.