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TFSAs (tax-free savings accounts) and RRSPs (registered retirement savings plans) are two of the most popular registered accounts held by Canadians, and they have plenty in common at first blush. They boast tax advantages on income (unlike non-registered accounts) and can hold a variety of qualified investments, including stocks, ETFs (exchange-traded funds), mutual funds, GICs (guaranteed investment certificates), bonds and more.
But for all their similarities, sometimes it can be beneficial to grow one before the other. Factors like one’s timeline (how long until the money is needed), tax considerations and one’s ability to contribute can all play a part in determining which account type may be more suitable for achieving specific financial goals.
If you find yourself wondering whether you should choose a TFSA or RRSP, ask yourself these three questions.
How soon do I need the money?
Perhaps you need the money sooner than later, or maybe you have longer-term goals around funding education, buying a home or retirement. Depending on your needs, there may be advantages to leaning more toward one than the other.
A TFSA helps you save for any goal – from next summer’s vacation abroad to supplementing your retirement later on — with tax-free growth. That means you can pull the money out at any time without impacting your taxable income, whether that includes capital gains on your investments or cash flow generated by dividends.
An RRSP is geared more specifically toward retirement savings, with tax-deductible contributions and tax-deferred growth of your investments. It is possible to withdraw funds from an RRSP without paying tax before retirement in a couple of situations. First-time homebuyers can withdraw up to $35,000 from their RRSP toward a home purchase (Home Buyers’ Plan); similarly, investors can withdraw up to $20,000 to pay for education (Lifelong Learning Plan). The borrowed amounts must be paid back within 15 and 10 years, respectively.
How might my income change?
Put another way, is it more advantageous to reduce your income taxes now or later in life? For many investors, the tax implications of each account type play a big part in deciding between prioritizing contributions to a TFSA or RRSP.
Investors contribute to a TFSA with after-tax income. That means if you’re an earner in a lower tax bracket who expects your income to increase over time – say, a young professional who just started your career – it could be more efficient to contribute to a TFSA while your income is taxed at a lower rate. Later on, any TFSA withdrawals won’t be added to your (now hopefully greater!) income.
RRSP contributions, on the other hand, are made with pre-tax incomeand can be used to lower your income tax bill at the end of the year or in future years. However, any funds you pull out of your RRSP are considered taxable income. High earners and folks in their peak earning years may benefit from contributing to an RRSP in order to cut down their tax liability. Additionally, these same investors could benefit from deferring paying tax on RRSP contributions until later in life. Retirees typically earn less than when they were earning employment income, and are more likely to pay tax at a lower tax rate when they withdraw.
How much would I contribute?
It is also important to consider how much of your current income you are willing or able to contribute to either account type.
The TFSA contribution limit is defined annually by the Canada Revenue Agency (CRA) – for example, the limit for the 2023 tax year is $6,500. If you contribute less than your maximum, any unused contribution room is carried forward from the day you are eligible for an account. For RRSPs, the contribution limit is 18 per cent of earned income reported on your tax return the previous year, up to a maximum of $30,780 for the 2023 tax year.
If you’ve already maxed out one account type (go you!), you could open and fund the other if you haven’t yet reached your savings goals for the year. Keep in mind: Over-contributing to a maxed-out TFSA or RRSP past a certain limit can carry penalties if the money isn’t removed in time. Some investors may be caught unaware, especially if they receive a boost through employer matching. You can see how much TFSA and RRSP contribution room you have available through “My Account” on the Canada Revenue Agency website.
Once you have determined whether you should open an RRSP or a TFSA (or both!), visit Find my Investment Fit where you can complete a short quiz that will direct you to the investment platform at RBC that may be a good fit for you.
Financial planning services and investment advice are provided by Royal Mutual Funds Inc. (RMFI). RMFI, RBC Global Asset Management Inc., Royal Bank of Canada, Royal Trust Corporation of Canada and The Royal Trust Company are separate corporate entities which are affiliated. RMFI is licensed as a financial services firm in the province of Quebec.
This article is intended as general information only and is not to be relied upon as constituting legal, financial or other professional advice. A professional advisor should be consulted regarding your specific situation. Information presented is believed to be factual and up-to-date but we do not guarantee its accuracy and it should not be regarded as a complete analysis of the subjects discussed. All expressions of opinion reflect the judgment of the authors as of the date of publication and are subject to change. No endorsement of any third parties or their advice, opinions, information, products or services is expressly given or implied by Royal Bank of Canada or any of its affiliates.