TFSA vs. RRSP | What’s The Difference?

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TFSA vs. RRSP | What’s The Difference?

Written by Bryan Daly
Fact-checked by Caitlin Wood

TFSA vs. RRSP | What’s The Difference?

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Investing Retirement RRSP Saving TFSA

Someday, you may want to start investing and make passive income for future use. Then again, if you’re not an experienced investor, the concept of committing your time and savings to something that might not have a great pay off can be nerve-racking. 

Luckily, there are some less risky investment accounts available for beginners in Canada. Two of the most common are the TFSA and the RRSP. Keep reading to learn the differences between these accounts and which you should invest your money in. 

What is a TFSA?

Short for Tax-Free Savings Account, a TFSA is a standard financial account that your bank or credit union will offer you after you’ve turned 18. As its title suggests, the main benefit here is that you won’t have to pay tax on the interest the account accumulates over time and any money you withdraw from the account is tax-free.

Despite its name, the TFSA should be handled more like an investment nest egg, rather than a traditional savings account. While you can dip into it whenever you want, the most ideal results occur when you leave your money in the account for a long time, so it can generate interest and be put to use later in life. 

Although income is what most consumers contribute to their account, you can also put other kinds of financial assets into your TFSA, such as:

  • Guaranteed Investment Certificates
  • Stocks & Bonds
  • Regular Savings Accounts

The federal government has imposed limits for how much you’re allowed to deposit into your TFSA annually. The maximum contribution amount can be different every year. Check with the CRA to verify your yearly contribution room and also your total available contribution room. Overcontributions are penalized

What is an RRSP?

A Registered Retirement Savings Plan is another type of government-sponsored investment account that you can activate through your financial institution, which also has a specific annual contribution limit. Essentially, RRSPs were created as a way to prompt Canadians into investing toward their eventual retirements and provide them with various tax advantages along the way, such as smaller yearly income tax bills.    

However, unlike a TFSA, an RRSP account is not tax-free but rather “tax-deferred”, meaning you don’t have to pay income taxes on your contributions during the year you deposited them. Instead, they’ll be taxed later on when you make a withdrawal. The goal is to refrain from doing that until you’re purchasing a home, financing your education or you’re past age 71. 

The annual RRSP contribution limit that you have to follow is set by the Canada Revenue Agency and is based on your particular income. The limit you’re allowed to deduct on your income taxes is normally around 18% of your yearly income.

The Differences Between a TFSA and an RRSP

It’s true that both TFSAs and RRSPs are sanctioned by the federal government and have specific contribution limits that you must follow to avoid any penalties. However, there are a few key differences that you should know about, including but not limited to:

The Tax Advantages

Both TFSA and RRSP accounts have different tax benefits:

  • Tax-Free – Remember, if you remain within the designated annual contribution limits, any funds you withdraw from or deposit into your TFSA won’t be taxed. If you contribute too much, even if it’s only a cent more, you’ll be penalized. 
  • Tax-Deferred – While you must declare your contributions during tax season, they won’t be taxed until you withdraw from your RRSP. Additionally, if you withdraw before age 71, you could lose that extra contribution space. 

How Much You Can Contribute?

As of 2021, here are the annual TFSA and RRSP contribution limits in Canada:

  • TFSA Annual Maximum – $6,000 (varies from year to year)
  • TFSA Lifetime Maximum – $75,500 (for contributors who turned 18 before 2009)
  • RRSP Annual Maximum – $27,830 or 18% of your earned income from the previous year (whichever amount is lower)

Currently, there is no lifetime maximum contribution limit for RRSP accounts. 

How Much You Can Withdraw 

Here are the withdrawal rules imposed by the federal government and the CRA: 

  • TFSA – You can withdraw when you want, in whatever amounts (tax-free) but can only replace the money you withdraw the following year. 
  • RRSP – Technically, you can also withdraw at any time, in any amount. However, all withdrawals, including your eventual cash-out, will be subject to tax.

The Expiry Date

TFSAs and RRSPs also have different account expiration conditions:

  • TFSA – Your account does not have an expiry date.
  • RRSP – By December 31st of the year that you turn 71, you need to arrange for your account to be converted into a Registered Retirement Income Fund (RRIF).

Should You Invest in a TFSA or an RRSP?

There are plenty of reasons why you should contribute to a Tax-Free Savings Account or a Registered Retirement Savings Plan. If you have the financial power, it can even be a great idea to regularly contribute to both types of accounts annually.

All that said, you may only have room in your life for one investment account. In that case, the one you choose should depend on factors such as your:

Current & Future Income

According to financial experts, Canadians earning moderate incomes and retirement savings or pensions are better off investing in an RRSP. The same goes for anyone making a high income. The more money you contribute over the years, the easier it will eventually be to finance your future goals. 

If your income surpasses your RRSP’s yearly contribution limit by a large amount, it can’t hurt to consistently deposit a portion of it into a TFSA for safekeeping.  

Savings Goal(s)

Since penalties can apply for withdrawing and there’s a lot of extra paperwork involved, an RRSP can be a safer choice when you’re trying to save up for more important long-term goals, such as financing a house, your education or your retirement. 

Then again, a TFSA may be more convenient because you can withdraw whenever you want, in whatever amounts, without penalty. This can make your TFSA a better choice when you’re making a down payment on a house or vehicle, building an emergency fund or covering short-term expenses (groceries, new appliances, etc.). 

Age

If you’re relatively young and expect to move to a higher tax bracket when you make a better income, it can be a good idea to store your savings in a TFSA. That way, you can transfer them into an RRSP later in life and receive better tax benefits someday.

As a senior, investing in a TFSA can also be great because it has no age limit or expiry date, unlike an RRSP, where you must start withdrawing after you turn 71. Plus, your Guaranteed Income Supplement (GIC), Old Age Security (OAS) or other retirement benefits may be withheld if you contribute to or withdraw from your RRSP or RRIF. 

How Do You Invest With a TFSA or an RRSP?

In Canada, there are a number of financial institutions and platforms that can help you open and invest in a TFSA or an RRSP, such as:

Robo-Advisors

One of the easiest forms of investing, robo-advisors allow you to contribute to various accounts and portfolios using any computer or mobile device. All you have to do is answer several financial questions and the robo-advisor will generate suggestions. You can then choose a TFSA or RRSP and pre-authorized contribution amount.

After your account is established, the robo-advisor should manage everything for you, including any deposits and rebalancing. Perfect for beginner investors, you can save up and earn passive income from the comfort of home, sometimes at a better price than a professional advisor. Be careful, as all robo-advisors have different rates and conditions. 

Online Brokerages

There are also many online investment platforms in Canada. Unlike robo-advisors, which offer pre-arranged options, you can use this type of brokerage to create, modify and monitor your own TFSA or RRSP account. More experienced investors use these platforms because they have fewer limitations than other alternatives.  

While you may have to pay service fees and other costs following certain transactions, some online brokers are cheaper than robo-advisors in the long-term. Depending on which platform you choose, you may even find accounts and investment options that aren’t offered by any robo-advisor or financial institution. 

Banks & Credit Unions

If you’re not sure whether a robo-advisor or online brokerage is your best option, most banks and credit unions offer their own TFSA or RRSP programs. Here, you’ll receive all the security of a top tier financial institution and have the opportunity to speak face-to-face with a professional advisor to determine which account is the better choice.

Although you may encounter fees along the way, at least you’ll know who is handling your money and where it’s going. If you prefer, your advisor can direct you to the investment accounts with the least risk involved. Plus, as a qualified member, you may be eligible for benefits that aren’t available with robo-advisors or online brokerages.

Frequently Asked Questions

Can an RRSP only be used for retirement?

The Canadian Government originally created the RRSP to get residents to save for retirement. That said, there are two other ways you can use the money in your RRSP:
  • RRSP Home Buyers’ Plan – Borrow up to $35,000 from your RRSP (typically in a lump sum) to finance a home. While you’ll have to repay what you’ve borrowed within a maximum period of 15 years, the money you withdraw for the Home Buyers’ Plan is tax-free. 
  • Lifelong Learning Plan (LLP) –  Borrow up to $20,000 from your RRSP over a maximum period of 2 years to finance you or your spouse’s full-time training or education costs. You’ll then have 10 years to repay what you’ve withdrawn. 

If I have a low income, should I invest in a TFSA or an RRSP?

Your tax bracket may be one of the more significant factors when choosing between a TFSA and an RRSP:
  • An RRSP is a better choice if you have a high income of $50,000 annually or more. That’s because whatever funds you deposit into the account are tax-deductible and your deductions reduce the total amount of taxes you owe. 
  • A TFSA may be a safer option if you make a low income of less than $50,000 annually, since your deduction will have a lower value and, after collecting any tax credits, you probably won’t have to pay as much income tax overall.

Is an RRSP tax-free?

No, as mentioned earlier, the money you contribute to an RRSP is “tax-deferred”. So, while your savings may be taxed someday, that will only happen when you withdraw. Until then, you’re exempt from paying income tax during the year a deposit is made.

Investing Glossary

Terms
Annual Report

A yearly report provided by a company to its shareholders that discusses the business activities and finances from the past year.

Annuity

An annuity is a financial product that pays out a guaranteed income. It is used mainly by those who are putting a retirement plan together. When an investment is made in an annuity, it then makes regular payments at a date or dates in the future to create an income stream for retirement.

Asset Allocation

A type of investment strategy that aims to balance risk and rewards by adjusting the portion of money invested in different types of assets in an investment portfolio. The specific investment strategy depends on the risk tolerance, time frame and goals of the investor.

Bond Fund

A mutual fund that invests in bonds or similar debt securities, also known as a debt fund. 

Bond Maturity

The term to describe time passing throughout a bond’s term. At the bond’s maturity date, the end of a bond’s term, the principal and interest will become due to the investor. 

Bonds

A type of debt security or financial instrument that represents a loan made between an investor and a borrower. The borrower is often a corporate or government body. Bonds are lower risk and yield less return than other types of investments. 

Common Stock

A type of equity ownership in a corporation. Holders of common stock vote on corporate policies and elect the board of directors.

Diversification

Investors are typically encouraged to diversify their loan portfolios in order to hedge against risk and garner the highest returns since different assets react differently to the same economic events. Diversification refers to a portfolio that consists of various assets that are not correlated with one another.

Dividend

An amount of money that is paid on a regular basis by a company to their shareholders. The amount paid comes out of the company’s profits.

Dividend Yield

The ratio of a company’s dividend per share to the price per share. The dividend yield communicates how much dividend income you received in relation to the price of the stock. The ratio is most commonly expressed as a percentage.

Enterprise Value

A measure of a company’s total value typically used as an alternative to equity market capitalization. The calculation considers market capitalization, short term debt, long term debt, and cash on hand.

Equity Fund

A mutual fund that invests primarily in stocks, also known as a stock fund.

ETF

ETF stands for exchange-traded funds. To put it simply, an ETF is like a mutual fund where it is comprised of securities like stocks and bonds and, like stocks, can be traded on the stock exchange. You are able to buy and sell shares of the ETF, like a stock, without having to buy each bond, stock and other securities separately. You own a part by buying the ETF which is comprised of these securities.

Guaranteed Investment Certificate (GIC)

A GIC is considered a low-risk investment vehicle because it is guaranteed. It works similar to a savings account because the money deposited in it earns interest.

Index Funds

A type of mutual fund that is built to match or track a financial market index, such as S&P 500. Index funds are low risk which makes them safe investments, but there is little opportunity for big earnings.

Investment

When an individual or entity contributes money towards something with the intention of turning a profit or gaining a material outcome, it is considered an investment. All of the money invested would be considered an individual or entity’s investments.

Investment Advisor

An individual or group that manages money or makes financial suggestions on behalf of another individual or group in exchange for a fee. 

Market Cap

The market value of a public company’s outstanding shares. The market cap is calculated by multiplying the share price by the outstanding number of shares.

MER

MER stands for the management expense ratio. The management expense ratio includes management fees, operating expenses, and taxes associated with a fund.

Mutual Funds

A mutual fund is a portfolio of different securities (stocks, bonds, short-term debts) that many people can invest in. Rather than diversifying your investments by buying different securities yourself, you can invest in a mutual fund. Depending on how much you invest, you will own a share of the mutual fund. This allows investors to have their hands in different stocks with one transaction.

Number of Holdings

The sum of all holdings types in a fund, investment or portfolio. For example, if you have a portfolio with common stock, bonds and preferred shares, the number of holdings would be three.

Par Value

Par Value – Par value refers to the value of a stock as stated on the stock certificate or the corporation’s articles of incorporation. The par value per share is typically of very little or no value.

Portfolio Management

The professional science and art of executing investment decisions and performing investment activities on behalf of an individual or institution.

Portfolio Rebalancing

Portfolio rebalancing is the act of consistently balancing your investments according to your needs by buying and selling assets.

Preferred Stock

A type of equity ownership in a corporation. Holders of preferred stock have a higher priority when it comes to dividends or asset distribution when compared to common stockholders.

Premium Bond

A premium bond is one that costs more than its face value. Bonds may trade at higher values as a result of a higher interest rate compared to current market rates.

Price to Earnings Ratio

The ratio of a company’s share price to earnings per share. This ratio is used to determine if a business is overvalued or undervalued.

Price-to-Book (P/B) Ratio

The P/B ratio refers to a company’s stock price divided by its book value per share (total assets less liabilities). Low P/B ratios may be a sign of an undervalued stock.

Reinvest Dividends

The process of investing dividend cash payments into the company or fund that provided that dividend.

Risk Tolerance

Risk levels vary with different investments. While some investments come with low risks, others are riskier in nature. Risk tolerance refers to the amount of risk that an investor is willing or able to undergo when investing in a particular investment vehicle.

Share Price

The price of a sole share in a company. A share price is not fixed and fluctuates depending on market conditions.

Shareholder Value

The value brought to equity owners of a corporation as a result of management’s actions to increase sales, free up cash flow, boost earnings, pay out dividends, and earn capital gains for shareholders.

Stockbroker

A professional who purchases and sells securities on a stock exchange for their clients.

Stocks

A type of debt security or financial instrument that represents ownership share in a company. Issuing stock is a way for companies to raise money and investors to turn a profit. Stocks carry more risk, but have the possibility for greater returns. Once you own a share of the company you can gain money through dividends paid out by the company or by selling the stock for a higher price than when purchased.

Tax-loss Harvesting

The practice of selling an asset or security that has incurred a loss with the intention of offsetting taxes on capital gains and income. Using the proceeds of the asset or security sale, a similar asset or security is purchased to maintain optimal returns and investments.

Volatility

The statistical level of variation of a trading price over time. Often, volatility is measured using the standard deviation of logarithmic returns. When volatility is high, the risk of investment is also high.

Yield to Maturity (YTM)

Yield to maturity refers to the total anticipated return on a bond if it is retained until maturity. If an investor holds onto a bond until it matures, the YTM is the rate of return of an investment if all scheduled payments are made and reinvested at the same rate.


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