TFSA vs RRSP: how to choose between them

The quick difference

The main difference between a TFSA and an RRSP is when you pay tax. With an RRSP, you can deduct contributions from your income now and generally pay tax when you take the money out. With a TFSA, you put in money you’ve already paid tax on, and growth and withdrawals are generally tax-free.

Neither account is an investment by itself. Both are containers that can hold savings, GICs, funds or stocks, depending on where you open them. So the real question isn’t which is better in general. It’s which tax treatment suits your income today, your plans for the money and how soon you might need it.

How a TFSA works

A Tax-Free Savings Account lets money grow without tax on interest, dividends or capital gains, even when you withdraw. Contributions are not tax-deductible. Residents of Canada start building contribution room at 18, and unused room carries forward to later years, so you don’t lose it by waiting. When you take money out of a TFSA, that amount is added back to your room on January 1 of the next calendar year, not right away. Putting it back in the same year can create an over-contribution if you don’t have spare room, and the CRA taxes over-contributions, even ones made by mistake.

How an RRSP works

A Registered Retirement Savings Plan lets you deduct contributions on your tax return, up to your RRSP deduction limit, which can lower the tax you owe for that year. Income earned inside the plan is generally not taxed while it stays there. Unused deduction room carries forward, and the year you turn 71 is the last year you can contribute.

Withdrawals are where the tax shows up. Money you take out is generally added to your income for that year, and your financial institution withholds some tax when you withdraw. There are special programs, like the Home Buyers’ Plan, that let you take money out for specific goals under their own rules.

Your tax rate now versus later

A common way to think about the choice is to compare your tax rate today with the rate you expect when you withdraw. If your income is higher now than it will likely be in retirement, an RRSP deduction saves tax at a high rate and the withdrawal is taxed at a lower one. If your income is low now, that deduction is worth less.

That’s why students and people early in their careers often look closely at a TFSA first, while people in higher brackets often look closely at an RRSP. These are patterns, not rules. Pensions, benefits that depend on income and future plans all change the picture, so it helps to run your own numbers or talk to a qualified adviser.

When flexibility matters

A TFSA is usually the more flexible of the two. You can withdraw without the amount being added to your income, and the room comes back the following year. That makes it a common home for medium-term goals, like a trip, a car or part of an emergency fund, as well as long-term saving. An RRSP is built for retirement, and taking money out early has a cost: the withdrawal is taxed and the contribution room you used generally doesn’t come back. Some people see that as a downside. Others like that it makes the money a little harder to spend on impulse.

Finding your own contribution room

Limits change over time and everyone’s room is different, so check your own numbers rather than relying on a figure you read online. Your RRSP deduction limit appears on your latest notice of assessment, and both your RRSP and TFSA room can be viewed when you sign in to your CRA account. Compare it with your bank’s records too, since recent deposits may not show yet.

Questions

Is a TFSA or RRSP better?

Neither is better for everyone. An RRSP tends to help more when your tax rate now is higher than it will be when you withdraw. A TFSA tends to suit lower incomes and goals where you may need the money before retirement. Many people use both.

Can I withdraw from my TFSA and put it back?

Yes, but the amount you withdraw is only added back to your room on January 1 of the following year. Re-contributing in the same year without enough room counts as an over-contribution, which the CRA taxes.

Where do I find my RRSP and TFSA room?

Sign in to your CRA account to see both. Your RRSP deduction limit is also printed on your latest notice of assessment. Check your own records as well, since very recent contributions may not appear yet.