One of the most common questions new investors have is: Should I invest with an RRSP or a TFSA? Let’s get one thing clear first - you can absolutely have both. It’s a great way to save for different goals at the same time.
But if you just want one to start with, or if you already have an RRSP and a TFSA and you’re wondering which to contribute to first, understanding their differences is key to getting the most out of your money.
The main differences between a TFSA and an RRSP
|Biggest benefit||Interest, dividends, or capital gains from any investments and savings in the account are tax-free. That means the government doesn’t tax you on your earnings - it’s all yours.||All contributions are tax-deductible. In other words, if you make $65,000 this year but add $10,000 to your RRSP throughout the year, you'll be taxed as if your income was $55,000 this year.|
|Contribution limit||As of 2021, the annual limit is $6,000. Unused contribution room is carried forward from previous years.||For the 2020 taxation year, the annual limit is 18% of the earned income you reported on your tax return in the previous year, up to a maximum of $27,230. For the 2021 taxation year, the limit would be $28,830. Unused contribution room is carried forward from previous years.|
|You don't pay tax on|
|You do pay tax on||Direct contributions to your account.||Money you withdraw from your account.|
You can withdraw as much as you want, any time, and it’s exempt from tax. There may be some exceptions to this. For example, if you’re holding GICs in your TFSA and you withdraw funds before they mature, you may pay a penalty.
Also, withdrawals made from your TFSA throughout the year can only be added back as contribution room at the beginning of the following year.
You can withdraw as much as you want, any time, but it’s subject to income tax. There are some exceptions to this. For example, if you’re holding GICs in your RRSP and you withdraw funds before they mature, you may pay a penalty.
Also, withdrawals don’t give you contribution room back unless you’re using the RRSP for the government’s Home Buyers' Plan or Lifelong Learning Plan.
|Investments you can hold in this plan||High Interest Savings Account, GICs, mutual funds, ETFs, bonds, stocks||High Interest Savings Account, GICs, mutual funds, ETFs, bonds, stocks|
|Expiration||Never expires.||You must cash out your RRSP when you turn 71.|
The answer to “when should I start investing” is always: as early as possible! When you put off investing you lose out on earning more interest and add the stress of scrambling to reach your savings goals.
So get started today with these tips on choosing a TFSA or RRSP based on your financial situation.
When to invest in a TFSA
A TFSA is a great choice if you’re saving for a goal earlier than retirement. In some cases, you can use it for retirement savings too. A TFSA doesn’t have the same tax benefits as an RRSP, but it’s more flexible because you can withdraw money any time without paying tax on it and the money you invest is growing tax-free. With a regular non-registered savings or investment account, you’d be taxed on whatever interest or gains you earn.
Good reasons to invest in a TFSA:
- You’re just starting out when it comes to savings and not making much money right now (less than $50,000 a year), so you won’t really benefit from the tax perks of an RRSP.
- You’re investing to save for a goal that’s earlier than retirement – like a wedding, down payment on a new home, emergency fund, new car, etc.
- You expect to use some of your savings soon and you don’t want to pay tax on the money you withdraw.
- You’re investing for retirement, you expect your salary to go up significantly soon, and you want to use your TFSA contribution room now so you have more room to contribute to an RRSP later, when you want to take advantage of greater tax benefits.
- You usually max out your RRSP contribution room and you want another option for tax-sheltered savings.
When to invest in an RRSP
The money you add to your RRSP is tax-deductible. This means that for every dollar you place into an RRSP, you can take a deduction against that year’s income. This means you could get a higher tax refund that you can invest right back into your RRSP or TFSA. So to get the most out of your RRSP, contribute to it when your income is higher and withdraw from it when your income is lower (like when you’re retired).
Good reasons to invest in an RRSP:
- You’re investing to build savings for retirement and you’re currently in a higher tax bracket (if you’re making more than $50,000 a year, for example).
- If you make more than $50,000 a year, you’re investing to build savings for your first home and you plan to use your RRSP as part of the Canadian government’s Home Buyers’ Plan (HBP). If you meet certain conditions, the HBP allows you to withdraw up to $35,000 tax-free to put towards the purchase of a qualifying home and pay back the withdrawn funds within a 15-year period.
- If you make more than $50,000 a year, you’re investing to build savings for your own education, and you want to use your RRSP as part of the Canadian government’s Lifelong Learning Plan (LLP)