Here are five things to think about when making your decision.

One of the most frequently asked questions is whether to invest in a registered retirement savings plan (RRSP) or a tax-free savings account (TFSA). Both will help you save money and avoid paying taxes, but they do so in different ways. Understanding these investments will help you determine when to use one or the other—and when to use both simultaneously.

What exactly is a TFSA?

The TFSA, which was introduced to Canadians in 2009, has proven to be extremely popular. Each year, you are given a $6,000 TFSA allotment, which means you can save that amount plus any rollover from previous years (assuming you were 18 or older in 2009, your lifetime limit is $69,500 as of 2020). Because this money has already been taxed (you contribute to a TFSA with your net income), there is no tax break at the time of contribution. However, any gains earned in a TFSA, whether from a savings account, a high-growth index fund, or another investment product, are not subject to capital gains tax, so you will not owe any tax on your earnings when you withdraw.

What is an RRSP? 

A registered retirement savings plan, or RRSP, allows you to invest up to 18 percent of your gross income per year, or $26,500, whichever is less, without paying income tax on that money. (If you invest after-tax dollars, the tax will be refunded once you file your income tax return for that contribution year.) 

In this way, an RRSP allows you to defer taxes while saving for retirement. The most important thing to remember is that you will be taxed on this money once you withdraw it. The idea is that because you will be retired, you will be in a lower tax bracket than during your high-earning years and thus will pay less tax overall because you invested in an RRSP.

Which is better, a TFSA or an RRSP? 

The “best” investment will be determined by your personal financial situation and goals. Remember that with a TFSA, you pay tax on the money you’ve earned before making a contribution, whereas, with an RRSP, you get a tax refund now on the money you contribute but must pay tax later on the money you withdraw from the plan. This difference, along with your income, investment timeline, and other factors, will all contribute to making the best investment decision for your money. You might discover that you can use both vehicles at the same time.

  1. Earnings and tax bracket 

Your income determines your tax bracket (the amount of income tax you must pay), and these factors will have a significant impact on which investments work best for you. 

Generally, those earning more than $50,000 per year should consider opening an RRSP. This is due to the fact that the money you put in is tax-deductible, and your deductions go toward lowering what you owe. For those earning less than $50,000 per year, the deduction is less valuable because you are unlikely to owe much income tax after claiming basic tax credits. In these cases, investing in a TFSA may make more sense.

  1. Time frame 

Which is superior? The quick answer is: 

RRSPs are used to save for long-term goals such as retirement. 

TFSAs for short or medium-term savings goals, such as an emergency fund or car purchase. It’s a good idea to know exactly what you’re saving for whenever you make an investment. Putting money aside for retirement usually takes more time than, say, putting money aside for your child’s education or a home renovation. 

Your RRSP funds are set aside for your retirement. The programme is designed so that when you withdraw the money, you will be earning less and thus falling into a lower tax bracket, resulting in a lower overall tax bill over your lifetime. This is effective for its intended purpose, but it is ineffective for short- or medium-term goals. That’s where a TFSA might come in handy because withdrawals are tax-free and penalty-free. Money saved in a TFSA can be easily withdrawn to buy a car, for example, with no tax consequences.

  1. Group strategies 

Which is superior? The quick answer is:

If you get a company match, almost always RRSPs (it’s free money, after all). 

If your employer matches your contributions to a group RRSP or a similar tax-deferred account, such as a defined contribution (DC) pension plan, investing in your RRSP could be even more valuable than usual. Employer contributions typically work by matching a percentage of your salary when you invest the same rate or a portion of what you contribute—sometimes dollar for dollar. This free money is a guaranteed return on your investment that would be nearly impossible to obtain through investing.

Let’s take a closer look. Even a 2% employer match on a $70,000 income results in an extra $1,400 in your RRSP—and your employer’s portion of the contribution may count towards your RRSP deduction for tax purposes. This double benefit will likely tip the scales in favour of a workplace account over other savings options unless the match is low or the investment options are poor.

  1. Purchasing your first home or putting money aside for education 

Which is superior? The quick answer is:

Because of the availability of the Home Buyers’ Plan and the Lifelong Learning Plan, most people invest in RRSPs. 

Remember how your RRSP is set up to help you save for retirement? There are two notable exceptions to this rule: the Home Buyers’ Plan and the Lifelong Learning Plan. 

The Home Buyers Plan (HBP) allows qualified home buyers to withdraw up to $35,000 from their RRSP to put toward their purchase. The withdrawal is tax-free but must be paid back within 15 years. This is an excellent way to obtain a large lump sum, such as for a down payment, and while it must be repaid, the “loan” is interest-free. 

Similarly, the Lifelong Learning Plan (LLP) is a programme that allows you to use your RRSP savings to pay for full-time education or training for yourself (or your spouse) for up to $20,000 over two years. The loan must be paid back within ten years.

  1. After retirement 

Which is superior? The quick answer is: 

RRSPs are almost always used (but depends on your income, as covered in section 1) 

TFSA withdrawals are always tax-free, whether you’re working or retired. RRSP withdrawals are always taxable. If you’re retired, you’re probably in a lower tax bracket than you were before, which means that RRSP withdrawals will be taxed at a lower rate than when you earned the money you contributed. Tip: If you receive a tax refund, you can maximize it by reinvesting the remainder in a TFSA. 

When it comes to retirement savings and planning, it pays to think long and hard about your choices—and to personalize them. Retirement planning, whether done alone or with the assistance of a professional, can help validate your options and assist you in setting goals for the future.