Should I Use a TFSA or an RRSP to Save For Retirement?

The Tax-Free Savings Account (TFSA) and Registered Retirement Savings Plan (RRSP) accounts are useful tools to save for retirement. While there are other uses for these accounts, many people think of them as ideal for retirement because of the ability to build tax-advantaged wealth over time.

What is the same about the RRSP and TFSA?

Income generated inside each of these accounts will not attract taxes right away. In the case of the RRSP, taxes are paid on withdrawal, which would be age 71 at the latest. Income in a TFSA will not attract taxes until the day of death and the assets roll into an estate account.

Should you gain or lose money in either of these accounts, you will not get taxed on the gains or be able to deduct the losses. Both of these accounts are individual in that they cannot be made joint or shared with another person. There is an exception with the spousal RRSP, which is used for specific situations between spouses. If you do not maximize the contribution room in either account, you can carry it to future years indefinitely.

What is different about the TFSA and RRSP?

The RRSP is taxed on the way in and on the way out. You will get a tax refund upon contribution and a tax bill upon withdrawal. The TFSA is not taxed in either case. RRSP contributions lower your income and RRSP withdrawals would raise your income on your tax return. The TFSA activity would not go on a tax return except for an estate planning scenario.

RRSP contributions are based on “earned income” which comes primarily from going to work, renting a property or running a business. TFSA room is based on a flat lifetime amount per person announced by the government each year and does not depend on what you earn.

Once you withdraw money from an RRSP, the contribution room is lost and must be re-established by earning more money. TFSA room is not lost due to withdrawal. The only exception is that if you withdraw money and redeposit it back into a TFSA within the same year, your redeposits and contributions added together should be under your maximum contribution limit. Not doing this may result in a penalty charged to you from the CRA.

Which account should you use to save for retirement?

The first question to ask is: Am I paying a lot of income taxes this year? If yes, the RRSP will be more beneficial since you will get a bigger tax refund upon contribution. If you are not paying taxes at all but have money to contribute, the TFSA would be a better choice. If you are paying taxes but have other deductions such as tuition credits that will eliminate your taxes without making a contribution, then the TFSA would be your preferred account. RRSP contributions are best suited for the years where you have the highest income and pay the most taxes.

A second question is: Is my cash flow uncertain and might I need this money? If yes, the TFSA would be your preferred account until you have certainty and can commit to a longer time period without accessing the money. The investment choices are also limited in this case due to a short time horizon, but the retirement theme can still be preserved. TFSA accounts can be used as emergency fund accounts since money can be withdrawn at any time. You can withdraw money from an RRSP at any time, but the tax penalties and loss of room make the retirement assumption hard to fulfil should this happen frequently.

The third question is: How much room do I have to contribute in each type of account? If you have “maxed out” one of the accounts, you may have to contribute to the other account if you want to do it today.

A fourth question to ask is: Is my employer contributing for my retirement already with a pension plan? If yes, and depending how much versus your RRSP room, the TFSA would be an addition to the retirement money you are already getting. If no, the RRSP would be the preferred choice until your contribution room is used up.

The last question to ask is: Can they be used together? Absolutely! You can transfer TFSA holdings to an RRSP without consequences. Transferring from an RRSP to a TFSA would trigger a withdrawal and a tax bill, so this is not recommended except in specific situations. You can also contribute to both types of account at the same time if this is suitable to your situation.

The good news is that when you save for retirement, these accounts are not mutually exclusive. Both can be used for a solid plan.