How Do TFSAs Work?

Any Canadian resident who is 18 or older may open a TFSA (tax-free savings account) and use it for simple savings or to hold investments. Most commonly it holds bonds, stocks, cash, guaranteed investment certificates (GICs), and exchange-traded funds (ETFs).

Taxes are not applied to any earnings made in the account, even when you make a withdrawal. This includes any interest, stock dividends, and capital gains made in your TFSA — it’s all tax-free.

But unlike RRSP payments, TFSA donations won’t lower your taxable income.

There is an annual cap on the amount of money you can put into your TFSA. The unused contribution room can be carried over to the current lifetime maximum amount, though. You have an allowance of about $6,000 available for your TFSA each year, so you can contribute that sum, plus extra if you have any rollover from prior years.

Note that any profits you realize from those assets won’t reduce your ability to make contributions this year or in the future. In essence, you don’t pay taxes on the income you receive within your TFSA.

So how does a TFSA avoid taxes? Since you contribute to a TFSA from your net income, the money you deposit into it has already been subject to tax. Therefore there is no tax advantage at the time of contribution. You just won’t be taxed again when you make a withdrawal.

How Do RRSPs Work?

A registered retirement savings plan, known as an RRSP, will hold both savings and investments. This account offers you the opportunity to make big annual contributions — the real benefit is that, according to how much you donate, it lowers your taxable income. An RRSP helps you postpone taxes while putting money away for retirement.

It’s vital to keep in mind that whenever you withdraw this money, you will owe tax on it. When you turn 71, you must turn your RRSP into a registered retirement income fund (RRIF) that you can withdraw from, since you can no longer make contributions to it. You’ll start paying tax on the money you contributed.

The premise is that since you invested in an RRSP, you pay less tax overall — because you’re paying as a retiree, in a lower tax bracket, as opposed to paying tax during your high-earning years where more tax is expected of you.

How The TFSA Vs. RRSP Choice Will Affect You

Your most effective investment will hinge on your unique financial circumstances and priorities. Remember: With an RRSP, you receive a tax refund now on the money you contribute, but will have to pay tax later when you use it as income. In contrast, with a TFSA, you pay tax on money you’ve earned before you make a contribution.

Consider your current earning potential, what you expect to earn in the future, your schedule for investing, and whether you anticipate tapping into savings sooner or later. You might even discover that you can capitalize on both accounts at once. So, which should you invest in more, your TFSA or your RRSP? Here’s some preliminary advice based on your stage of life.

Modest Income

Saving in a TFSA is preferable to saving in an RRSP if you are in a lower-income tax bracket (for instance, if you’re on maternity leave or pursuing education). At the lower end of the income spectrum, the tax benefits of RRSPs are less significant, especially compared to the opportunity to grow your savings in a TFSA.

Middle Class

There might not be a definite benefit to adopting one plan over the other if you fall into the intermediate income tax bracket. One tactic is to make TFSA contributions now and build up RRSP space for use later if you anticipate being in a higher tax bracket where you can take full use of the tax benefits.

High Income

When your tax bracket is high, use both accounts. If you have to pick one: If your current tax rate is greater than you anticipate it to be when you withdraw your investments, an RRSP is a wise choice. As a bonus, you can source your TFSA contributions from the refund from your RRSP contribution.

Get An Expert Opinion On Your Financial Situation

You can save in a TFSA, an RRSP, or both — as long as you decide based on your savings needs, eligibility for income-tested benefits, and your present and projected financial status. But it’s still hard to assess all those factors at a glance. Contact us today for an objective, in-depth look at your financial options.

When you book your free consultation call, we’ll listen to you first as you explain your circumstances and priorities. Then we’ll walk you through setting up the most advantageous investing approach.

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