RRSPs vs. TFSAs | How Should You Invest Your Money?

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What Are RRSPs

Registered Retirement Savings Plans (RRSPs) are retirement savings plans that are registered with the Canada Revenue Agency and that you and/or your spouse or common-law partner can contribute to. When you contribute money to your RRSP, that money can grow over time through investments.

Contribution room is based on 18% of your income earned the previous year to a maximum, and is reduced by pension plan amounts. RRSP contributions are tax deductible and can reduce taxes that you owe, and you can also choose to delay your deductions to a subsequent year. The income you earn through your RRSP investments are exempt from being taxed as long as your funds are untouched and left within your RRSP.

When money is taken from your RRSP, your full withdrawal is taxed as income. Unfortunately, even capital gains and dividends earned within the RRSP are considered as regular income even though when not in an RRSP they receive better tax treatment.

You can take money out of your RRSP either when you retire, or when you are purchasing or building a qualifying home for yourself or for someone related to you who has a disability. When taking money from your RRSP to put towards a home, you may only take out a maximum of $35,000 and the money must be repaid to your RRSP within 15 years of the withdrawal. Withdrawing from your RRSP becomes mandatory starting after you reach the age of 71.

RRSP accounts can be set up through financial institutions like banks, credit unions, trusts, or insurance companies. You can choose to set up a self-directed RRSP if you would like to personally build and manage your own investment portfolio, or you can let your financial institution manage your portfolio for you.

For business owners, RRSP planning can be especially complicated since you can set your own income levels and your income may be lower while running your business and higher in your retirement years, so RRSPs may not be your best option for investing money for retirement.

Learn more about RRSPs here.

What Is a TFSA

Tax Free Savings Accounts, or TFSAs, are a flexible, registered, general-purpose savings vehicle that allows you to earn tax-free investment income. Contributions to a TFSA are not deductible for income tax purposes and the money earned within the TFSA account through investments or capital gains is tax-free, even when withdrawn. Money can be removed from your TFSA at any time, and withdrawals can be recontributed in the following year.

There is a set amount of contribution room for TFSAs each year. The lifetime limit is $81,500 in 2022 for those who have never contributed before. The limit is expected to be increased by $6500 in 2023.

Similar to RRSPs, TFSAs can be set up through financial institutions like banks, insurance companies, trust companies, and credit unions, and you can choose to personally build and manage your own investment portfolio if you prefer.

Learn more about TFSAs here.

RRSPs vs. TFSAs

  RRSP TFSA
Are there contribution limits? Yes Yes
Are contributions tax deductible? Yes No
Are savings grown within the account tax free? Yes Yes
Are withdrawals taxable? Yes No
Can I get government grants? No No
Do withdrawals affect my other benefits? Yes No

 

Should You Invest in an RRSP or a TFSA?

RRSPs are one of the few last minute and flexible deductions available to people with employment income from a T4. However, if you are a business owner and have some control over your salary, and even if you don’t, you should consider some alternatives first before deciding on an RRSP.

A TFSA provides tax-sheltered growth throughout the life of the investment. This can be a substantial benefit compared to an RRSP which does provide a tax deduction when you contribute, but 100% of the income is taxable when it’s withdrawn.

A non registered investment is another option that is often chosen as a way to invest for business owners wanting to keep the capital in their corporations. You avoid having to record the withdrawals from the company as extra salaries or dividends. This is also available to anyone not wanting to contribute to a registered investment account.

Another option that is not widely known or used, but which can be a good addition to some portfolios, is investing through life insurance products. These investments are tax sheltered, asset protected, and provide insurance protection as an added benefit.

RRSPs are widely understood and advertised and can be the right choice for many, but they need to be considered as part of your entire portfolio to make sure they are the right choice for you. Consultation with your investment manager and your accountant is the best course of action. Making sure that an RRSP contribution is the right choice before you make it will help you design the best investment portfolio for you.

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