TFSA – Tax Free Savings Account – is an account that does not apply taxes on any contributions, interest earned, dividends, or capital gains, and can be withdrawn tax free
RRSP – Registered Retirement Savings Plan – is a retirement savings plan that you establish, that is registered by CRA, and to which you or your spouse or common-law partner contribute. Deductible RRSP contributions can be used to reduce your tax.
The main difference between the RRSP and TFSA is how your income is taxed when you contribute or withdraw from each account.
The RRSP is a tax-deferred account, which means you contribute to it with pre-tax incomes and you’ll pay your income taxes on your withdrawals;
In contrast, the TFSA is a tax-free account – meaning you contribute to it with after-tax income, so you’ll pay no more income taxes when you make a withdrawal. Because of this tax structure, you should come out with about the same amount of money whether you choose the RRSP or TFSA, which is why you shouldn’t sweat your TFSA vs RRSP decision too much.
For example, here’s what happens when you compare putting your earned income in a TFSA vs RRSP:
| TFSA | RRSP | |
|---|---|---|
| Gross earned income | $1,000 | $1,000 |
| Income tax (30%) | $300 | $0 |
| Net contribution | $700 | $1,000 |
| Value after 30 years at 6% | $4,020 | $5,743 |
| Income tax at withdrawal (30%) | $0 | $1,723 |
| Net | $4,020 | $4,020 |
Facts about TFSA & RRSP
| TFSA | RRSP | |
|---|---|---|
| Flexibility | Can be withdrawn anytime and used for anything | Can’t take out money penalty-free except for buying your first home or under the Lifelong Learning Plan |
| Tax Rules | Tax-sheltered growth on investments | Tax-sheltered growth on investments |
| Direct Contribution | Can contribute directly (up to $63,500 total as of 2019) | Can contribute directly (18% of previous year’s earned income up to $26,500 for 2019) |
| Tax deductions | No tax deduction for contributions | You get a tax deduction in the year you make a contribution |
| Withdrawal Rules | Withdraw any amount at any time, without paying income tax | Withdraw any amount at any time, subject to income tax |
Bottom line? If you are a high income earner, it is best to contribute to your RRSP and get the maximum tax deduction on your personal tax return. Refund which would generate as a consequence to that deduction can be further contributed to earn tax-free income. WIN-WIN!
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