What is the difference between an RRSP and a TFSA?
These two savings vehicles meet different needs:
- An RRSP is a long-term savings vehicle intended for retirement, reducing the payable taxes on your current income when you save it for the future.
- A TFSA is a complimentary tool to help save for short-term goals (travel, education, renovations). They can also be useful in saving for retirement as they do not affect the amount of government benefits you receive, unlike RRSPs.
RRSP contributions can be deducted from your taxable income, whereas TFSA contributions are made with income that has already been taxed. This means they aren’t tax deductible.
That having been said, if funds are withdrawn from an RRSP, they will be considered taxable income and taxed at the rate based on a person’s current income, which is not the case with a TFSA.
Which one is best?
As with any financial portfolio, diversification should be a key aspect of a retirement savings plan. Opting for RRSP and TFSA accounts are conducive to building tax-sheltered savings.
A financial advisor can help determine which one would be more advantageous in a given situation. If the tax rate is higher now than it will be at retirement, an RRSP is likely the better option. However, if a person’s retirement income will be higher than their current income, they’re better off with a TFSA.
Government benefits may be reduced if pension income is considered in their calculations. Unlike with TFSAs, RRSP withdrawals are considered income. Therefore, a TFSA may be more advantageous as it better manages the total taxable income.
Nearing retirement age? Remember that at age 71, all RRSPs must be converted to Registered Retirement Income Funds (RRIFs), which will have a fiscal impact. In the case of RRSPs, funds are tax-deferred, but the tax rate will likely be lower at 65 or 70, as will a person’s income. This is not the case with TFSAs: with no age limitations, people can contribute throughout their life and, since they have already paid taxes on the funds invested, they will not be taxed again when withdrawals begin.
When it comes to estate planning, there are also major differences between the two vehicles from a tax standpoint. Both investment vehicles can designate a beneficiary. However, all amounts invested in an RRSP will be taxed upon the event of death (unless an eligible rollover is applied), while TFSA earnings cease to be tax-exempt after death.
| Key differences between an RRSP and a TFSA | ||
|---|---|---|
| RRSP | TFSA | |
| Which one to choose? |
Long-term savings vehicle intended for retirement. | Complimentary tool to help save for short-term goals. |
| Deductible or taxable? |
Contributions can be deducted from your taxable income. | Contributions are made with income that has already been taxed. |
| Income requirements for contribution |
Maximum contributions are determined based on a person’s income earned each year. | Income earned annually does not have an impact on contribution potential. |
| Withdrawals | When funds are withdrawn from an RRSP, they will be taxable. | When funds are withdrawn from a TFSA, they will not be taxable. |
| Age requirements | RRSPs must be converted to an income fund when a person turns 71 years old. | There are no age requirements for a person to use the funds in a TFSA. |