TFSA vs. RRSP: How should you save for retirement?

A young black couple sitting a table with a laptop reviewing their financial plan.

If you’re in your 30s, 40s, or even early 50s, now is the time to jump start your retirement savings.   With a significant time horizon until retirement, you can let the power of compounding go to work for you.

Taxes are another thing you want working for you, not against you, because they can take a big bite out of your investment earnings. So when saving for retirement, take advantage of registered investment accounts and their special tax features to help you save more, faster.

The two types of registered accounts you can use to save for retirement are the Registered Retirement Savings Plan (RRSP) and the Tax Free Savings Account (TFSA).

How does an RRSP work?

An RRSP is specifically designed with retirement as the end goal. One of the most popular features is that contributions made to the plan are tax-deductible (in the year made or a subsequent year) and thus are effectively made with pre-tax dollars. Your savings grow tax-free for as long as your money stays in the plan. However, withdrawals from the plan are taxable and the plan must be collapsed at the end of the year you turn 71. (Speaking of age, there is no minimum age to open an RRSP.)

You must have “earned income” in order to contribute, which is income from active sources like a business or employment. There is an annual contribution limit, but it’s cumulative, so if you don’t contribute this year, you can always catch up next year.

Finally, an RRSP can hold many different types of investments from stocks to bonds, GICs to exchange-traded funds.

How does a TFSA work?

A TFSA can be used to save for any goal including retirement. One of the biggest differences compared to an RRSP is that contributions are not tax deductible. But when you take money out, it’s not taxable and you can re-contribute in the following year, in addition to the annual maximum. Just like the RRSP, your savings grow tax-free for as long as your money stays in the plan.

You have to be 18 years old to open a TFSA but there is no age limit for making contributions. There is an annual contribution limit, which is currently $5,500 per year (indexed for inflation.) Contribution room is cumulative, so if you’re opening a TFSA for the first time in 2017, you can contribute up to $52,000. Like an RRSP, a TFSA can hold a wide range of investments. 

How do I know which one(s) to use?

You can use either an RRSP, a TFSA or both, as well as non-registered investment accounts. The latter have no special tax status, so you probably want to max out your RRSP and TFSA first.

As mentioned above, the timing of taxes is the biggest difference between an RRSP and a TFSA. If you think your marginal tax rate in retirement will be lower than it is today, an RRSP is a good choice because taxes are deferred until the money is withdrawn and you get a tax deduction today. On the other hand, if you think your marginal tax rate in retirement will be higher than it is today, a TFSA may be the better choice because withdrawals are not taxable. It’s probably best to consult with an expert who’s familiar with your specific financial situation .