TFSA (Tax Free Savings Account) and RRSP (Registered Retirement Savings Plan) are registered investment accounts in Canada that offers some tax advantages. For instance, investment profits on a TFSA are tax free whereas capital gains or dividends on a regular non-registered account are taxable income.
In summary, investments such as stocks, ETFs, savings accounts, and mutual funds can be held inside both TFSA and RRSP accounts. Deposits to RRSP are tax deductible whereas TFSA contributions are not tax deductible. Also, TFSA withdrawals are tax free while RRSP withdrawals are taxable.
TFSA and RRSP are not investment in themselves. Instead, you can choose what stocks or other investments to hold inside TFSA and RRSP accounts. TFSA and RRSP can give some tax advantages on the investments held inside it.
TFSA vs RRSP – Key Differences
RRSP – Best for retirement savings and investments.
TFSA – Best for medium to long term savings.
| TFSA | RRSP |
| Contribution Limit of $6,000 on 2021 | Higher Contribution Limit – 18% of your previous year’s income (up to $27,830 on 2021) |
| Dividends and investment income can grow tax free | Dividends and investment income can grow tax free |
| Deposits are not deductible | Deposits are tax deductible up to your contribution limit |
| Tax Free withdrawals | Withdrawals are taxable |
| Unused contribution limit are added back to next year’s limit | Unused contribution limit are added back to next year’s limit |
RRSP Main Advantages
1. Deposits are tax deductible while withdrawals are taxable. Thus, contributing when you are on a high tax rate (high income year) will give you more tax deduction. Also, withdrawing on your low income year may result to lower tax rates.
Low income year usually happens during retirement since there is little to no employment income. Hence, RRSP is designed for retirement savings.
For example, here are the combined marginal tax rates for federal and provincial income taxes on Ontario.
Combined 2021 Federal & Ontario Tax Rates
| Total Income | Marginal Tax Rates |
| first $45,142 | 20.05% |
| over $45,142 up to $49,020 | 24.15% |
| over $49,020 up to $79,505 | 29.65% |
| over $79,505 up to $90,287 | 31.48% |
| over $90,287 up to $93,655 | 33.89% |
| over $93,655 up to $98,040 | 37.91% |
| over $98,040 up to $150,000 | 43.41% |
Assume a person in Ontario earned $120,000 on 2021 and transferred $20,000 to an RRSP account. The $20,000 RRSP deposit will result to a tax savings of $8,682 (43.41% of $20,000).
Instead of $120,000 in taxable income, the $20,000 RRSP deposits will lower taxable income to only $100,000.
After 20 years, assume the same person retired. Any RRSP withdrawal will be considered as taxable income when filing taxes. As long as the total taxable income and RRSP withdrawal is below the first tax bracket, it will only be taxed at 20.05% (assuming tax rates stay the same).
For instance, a taxable pension income of $10,000 plus $20,000 in RRSP withdrawals would likely be subject to the first tax bracket. On the other hand, an RRSP withdrawal of $20,000 on a year with an employment income of $120,000 would result to $140,000 in taxable income. Tax rates will depend on your total taxable income from all sources.
Overall, RRSP is most beneficial when contributing on a high income tax year and withdrawing on a low income tax year, which usually happens during retirement when most people have no employment income. Funds on an RRSP can still be withdrawn anytime with no limit, but tax rates may be higher when you still have employment income.
Should the same $20,000 be withdrawn after a year when the same person earned $120,000, the RRSP withdrawal would be subject to 43.41% tax rates (total income of $140,000 will mean high tax rates). RRSP withdrawals are best used as a replacement of employment income.
2. Higher contribution (deposit) limit compared to TFSA. A $50,000 income on year will result to an RRSP contribution limit of $9,000 (18% of $50,000). For TFSA, the maximum amount is only $6,000 on 2021 no matter how much you earn.
For higher income of $100,000, the maximum becomes $18,000 which is much higher than $6,000. RRSP contribution limit is 18% of your income up to $27,830 on 2021. Should a person earn $200,000, the maximum RRSP limit applies at $27,830 even though the 18% is $36,000.
For both TFSA and RRSP, unused limits are added to your future TFSA and RRSP contribution limits. Should a person has a TFSA limit of $12,000 and deposit $2,000 on a year, the remaining $10,000 contribution limit can be used on future years.
3. Dividends, interest income, and investment profits inside an RRSP can grow and compound tax free. Taxes will only apply when you decide to withdraw. On a regular non-registered account, dividends have to be paid on the tax year it is earned and you have to pay capital gains when you sell a stock.
For RRSP, there will be no taxes when you sell a stock or any investment as long as the money stay inside an RRSP. For example, you can sell some stocks tax free even with a capital gain inside an RRSP as long as you do not withdraw it. It can be used to purchase other stocks or other kind of investments.
TFSA Main Advantages
- TFSA Withdrawals are added back to next year’s TFSA Contribution limit. Also, there is no limit on the amount of withdrawals.
2. Deposits and withdrawals on TFSA are tax free. Thus, you can sell stocks and withdraw some money anytime from a TFSA and it will be tax free.
TFSA is more flexible since you can withdraw funds anytime and you can simply deposit it back on next year.
For the full list of both TFSA and RRSP Contribution limit, here is a table on canada.ca. Both your TFSA and RRSP Contribution limit amounts can be found on your CRA account. Also, RRSP contribution limit are stated on Notice of Assessment after filing taxes.
Deposits above contribution limit for both TFSA and RRSP accounts are typically subject to 1% monthly penalty by the CRA. For RRSP, the penalty applies for deposits $2,000 above the contribution limit.
Investment Options inside TFSA and RRSP
- Stocks
- Bonds
- Savings Accounts
- GICs (Guaranteed Investment Certificates)
- Mutual Funds
- Managed accounts made up of stocks, bonds, etc.
There are several kinds of TFSA or RRSP accounts for each investments. Some Financial Institutions can hold stocks and mutual funds on a TFSA or RRSP account while a separate account may be needed to hold GICs and Savings accounts inside a TFSA or RRSP.
Multiple TFSA and RRSP accounts can be opened but the total deposits to RRSP and TFSA accounts are still subject to the Contribution Limit amount. Let us say a person have an unused TFSA Contribution Limit of $12,000 on a year. The total deposits on different TFSA accounts must be below $12,000.
Deposits above the limit on TFSA are subject to 1% monthly penalty.
TFSA and RRSP Savings Accounts & GICs
TFSA and RRSP Savings account have typically little to no risk and lower returns compared to different kind of investments such as stocks and mutual funds. Interest earned on a TFSA Savings account are tax free whereas interest income on a regular savings account are taxable.
The same rules for TFSA and RRSP applies for both TFSA and RRSP Savings accounts. TFSA Savings account withdrawals are tax free while RRSP withdrawals are taxable. At the same time, deposits to an RRSP Savings account are tax deductible.
Stocks & ETFs
Stocks are ownership of a company. Some of the most popular stocks in US and Canada are Apple, Tesla, Microsoft, Air Canada, and A&W stock. Individual stocks tend to be risky compared to other investments. Diversification is one way to lessen risk of investing.
S&P 500 is the most common stock market index. The returns of S&P 500 is influenced by the 500 largest stocks in United States. Anyone can invest on S&P 500 through ETFs (Exchange Traded Funds). US ETFs such as SPY and VOO and Canadian S&P 500 ETFs such as VFV and VSP copies the returns of the S&P 500.
ETFs is the most common way to diversify and own tens or hundreds of stocks at the same time. There are also ETFs that holds only bank stocks, clean energy stocks, gold mining stocks, or ETFs that holds high dividend stocks.
TFSA vs RRSP Tax Implications (Examples)
To better illustrate how these two accounts differ, here are two examples on how taxes affect investments.
| TFSA | RRSP | |
| Pre-tax contribution | $ 10,000 | $ 10,000 |
| After-tax (assume 40%) | $ 6,000 | $ 10,000 |
| Suppose +1,000% gain after 25 years | $ 66,000 | $ 110,000 |
| Withdrawal (after tax – 40%) | $ 66,000 | $ 66,000 |
On the second line, RRSP deposits are tax deductible so the whole $10,000 in income is invested. For TFSA, contributions are not tax deductible. A pre-tax income of $10,000 would only be $6,000 after paying 40% income taxes. Assume both investments increased by +1,000% (10 times), $60,000 and $100,000 increase respectively.
Lastly, TFSA withdrawals are tax free while RRSP withdrawals are taxable.
Note: The table assumes a 40% tax rate for both deposit and withdrawal, and a +1,000% increase to investments (10 times profits plus initial investment) resulting to investments multiply by 11.
In this table, we can see that both accounts will ultimately end up to $66,000. However, this table assumes that the tax rates for both deposit and withdrawal are at 40%. Should tax rates be lower during withdrawal, RRSP will give a better result.
Should the tax rates be only 20% during withdrawal, the RRSP after tax income would be $88,000 ($110,000 minus 20% of $110,000). RRSP is beneficial when you withdraw on a low income tax year which usually occurs during retirement.
With that said, TFSA is still better for short to medium term savings since you can withdraw TFSA investments anytime without worrying about tax consequences since it is already after-tax dollars.
How to Deduct Taxes on RRSP Deposits
Financial Institutions typically issues a RRSP Contribution receipt by March which includes the total RRSP deposits on the previous year. RRSP deposits are tax deductible. This receipt can be sent to an accountant or prepare your income taxes yourself before April 30 (usual tax filing deadline, but can be different on some years).
Is it better to invest in TFSA or RRSP?
It is better to start with a TFSA so you can have the flexibility of withdrawing anytime without worrying about taxes. TFSA is best for medium to long term savings while investing inside an RRSP is best during a high income year to get more tax deductible. Also, RRSP is designed for retirement.
Should I max out RRSP or TFSA first?
For most people, maxing out TFSA first before RRSP may be ideal to have more flexibility of withdrawing funds anytime without worrying about taxes. Also, TFSA usually have a lower contribution limit. On the other hand, maxing out RRSP first makes sense when you are earning more than $70,000 since this will give you tax deduction at a higher rate.
Given a choice, it may be best to have both funds on TFSA and RRSP. When you are starting out in life and have a low salary or a part-time employment, maxing out TFSA first makes sense since you would get little tax deduction on an RRSP on income below $40,000.
Can I have multiple RRSP and TFSA accounts?
Multiple TFSA and RRSP accounts can be opened as long as the total contributions are below your TFSA and RRSP contribution limit. However, deposits above your contribution limit may be subject to 1% monthly penalty by the CRA until withdrawn.