RRSP vs TFSA: which one is better?

As it usually happens with complicated questions, the answer is: it depends. Because RRSP and TFSA provide different kinds of benefits, either one is more suited to a certain life scenario.

To recap:

RRSP is a way to accumulate supplementary income in retirement, it accumulates with the employment income and provide an opportunity to delay the payment of taxes and reduce their amount. Penalty-free withdrawals from RRSP before your retirement are very restricted. Amounts taken out of RRSP in retirement are added to the total taxable income.

TFSA is a way to save for any goal, not just retirement, and the money in TFSA is more readily available should you need it before retiring. TFSA allows to earn tax-free income in the form of capital gain, interest and dividends, but it does not provide any tax relief on the amount of the investment itself.

So which one is better?

The downside of RRSP is that as soon as the money is allocated to it, the withdrawal from RRSP before retirement is quite restrictive. This situation does not provide flexibility if you are planning a significant purchase (other than your first home or education). Think a car, a new home (not your first home), a wedding. You will not be able to take out money from RRSP for that.

Another “red flag” for RRSP is that the withdrawals from it are considered a part of your taxable income. This may play out in a couple different ways.

If you are planning to have higher income in retirement than you do now (as fantasy-like as it sounds, if your employer provides a great pension plan, this can actually happen), then RRSP’s tax reduction feature is not for you. In fact, it can work against you due to the progressive taxation.

Government funded pension, such as OAS (Old Age Security), GIS (Guaranteed Income Supplement) will be significantly reduced is your income is retirement is higher that the set maximum.

TFSA, in comparison, is a container which is not limited to retirement savings. In fact, it is a tax-free way to save money for any goal and withdraw it without serious consequences when you need it. The only consequence of the withdrawal from TFSA is that the available TFSA contribution room temporarily goes down.

TFSA does not provide an opportunity to reduce or delay taxes on the amount of your investment. On the other hand, since the TFSA investment is “after-tax”, the money you take out of TFSA is not considered your taxable income. In retirement, withdrawals from TFSA will not reduce the amount of OAS or GIS.

To decide between TFSA and RRSP you need to answer several questions:

1. Will you need to use the money you have available for this investment, before retirement, for something other than the purchase of your first home or education? (YES: TFSA / NO: RRSP)

2. Will your retirement income be higher than your current income? (YES: TFSA / NO: RRSP)

3. Is your employment income low now but you expect it to grow in the future? (YES: TFSA / NO: RRSP)

4. In retirement, will you mostly rely on the government pension? (YES: TFSA / NO: RRSP)


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