A Sensible RRSP vs TFSA Comparison

A Sensible RRSP vs. TFSA Comparison

Should you contribute to your RRSP or your TFSA? It’s one of the most frequently asked questions here and on other financial forums, yet the answers couldn’t be more divided. Furthermore, there is a growing sentiment among Canadians that somehow RRSPs are a government scam because you’ll be forced to pay tax on any withdrawals in retirement. That leads many to (sometimes) incorrectly declare that a TFSA is the better savings vehicle for retirement due to the tax-free treatment of withdrawals.

Let’s start by clearing up one important fact in the RRSP vs TFSA debate: The accounts are mirror images of each other. When you put money in an RRSP and invest the tax refund, you’re using pre-tax dollars. The money grows inside a tax sheltered account and then you pay taxes on your withdrawals years later in retirement.

The opposite is true of a TFSA – you contribute with after-tax dollars but won’t have to pay taxes when you take money out. If you’re in the same tax bracket when you withdraw from your RRSP as you were when you made the contributions, the RRSP and TFSA work out to be exactly the same.

RRSP vs TFSA Comparison

Here’s a simple chart that David Chilton used in The Wealthy Barber Returns to help drive this point home:

Pre-tax income $1,000 $1,000
Tax $400 n/a
Net contribution $600 $1,000
Value in 20 years @ 6% growth $1,924 $3,207
Tax upon withdrawal (40%) n/a $1,283
Net withdrawal $1,924 $1,924

Two important caveats to keep in mind:

  1. You need to invest the tax refund in order for RRSPs to work out as designed. Unfortunately, most Canadians spend their refund and so they don’t end up with as much money in their retirement account.
  2. A TFSA is flexible in that you can take out money at any time without penalty. For Canadians who use a TFSA as their primary retirement savings vehicle that means resisting the temptation to raid the account whenever “something” comes up. You should also replace the ‘S’ in TFSA with an ‘I’ and make sure to invest that money for the long-term.

Obviously, for high income earners who expect to retire in a lower tax bracket, it makes more sense to contribute to an RRSP. For low income earners, or for young people with higher income potential later on in their careers, TFSA contributions make better sense now.

Related: How much of your income should you save?

Another advantage in favour of RRSPs is its higher annual contribution limits – 18% of your income up to a maximum of $27,830 in 2021 – compared the TFSA contribution limit of just $6,000.

One potential downside is that withdrawals from a large RRSP portfolio could trigger higher clawbacks from means-tested government benefits such as Old Age Security and the Guaranteed Income Supplement. TFSA withdrawals in retirement, on the other hand, don’t count as earned income and won’t affect your eligibility for OAS and GIS.

Fans of the Tax Free Savings Account trumpet the “tax-free” withdrawal stage while conveniently ignoring that contributions were made with after-tax dollars. And anti-RRSP zealots look to the big tax liability in retirement while ignoring all the deductions and years of tax-sheltered growth.

Final Thoughts

So who wins the great RRSP vs. TFSA comparison? It’s easy to say that you should max out both accounts every year, but realistically, unless you are blessed with a six-figure (plus) income, most of us will have to choose.

As Chilton concluded, it depends:

  1. If you go the RRSP route, don’t spend your refund.
  2. If you go the TFSA route, don’t spend your TFSA.
  3. Whatever route you go, save more!

Personally, I prioritized maxing out my RRSP contribution room when my income was in the $75,000 – $95,000 range. I maxed out my TFSA for the first three years (2009-2011) before draining the account to top-up our house downpayment in 2012. Then we bought a car and paid that off over four years – so I did not contribute to my TFSA from 2012-2016. I spent the next several years catching up on my unused TFSA contribution room, but by then I had already caught up on my unused RRSP room, so I was able to shift those extra contributions to my TFSA and fill it up faster.

Related: So you’ve made an RRSP contribution. Now what?

Now I’m onto the next debate – once you’ve maxed out both your RRSP and TFSA, what’s next? 

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  1. Marc on November 1, 2021 at 1:15 pm

    Hi Mr. Engen,
    Thank you for your articles.
    I personally have chosen to prioritize the RRSP for now due to the fact that the Canada child benefits and Quebec family allowances are based on the net income and thus with three young children any contribution gives an automatic 12% allowance increase for the next year, but I understand that it is another subject not covered here!

    What got me thinking though is the comment #1 saying that you need to invest the tax refund in order for RRSPs to work out as designed.

    If I look at the comparison table between RRSP vs TFSA and read that comment, I understand that my (for example) $400 tax return on my pre-tax income $1,000 RRSP contribution, I need to reinvest it to end up with the equivalent of if I would have used the TFSA account way.

    However, it is really the base $1,000 RRSP contribution that give $3,207 and a net withdrawal of $1,924 after 20 years, not $1,400 (plus the 40% return on that extra 400$, and so on).

    Might I suggest it be worded differently, where for the same initial $600 Net contribution, one would get $600 in his TFSA or $1,000 in his RRSP and both give you the same net amount in the end?
    For my part I had really read and understood at first that the 400$ return on the example needed to be reinvested to be equivalent, where in fact it is already invested compared to the $600 Net contribution in the TFSA.

    It is probably true to say “If you go the RRSP route, don’t spend your refund” if you compare the same contribution to a TFSA and RRSP, but possibly not the way the numbers are presented in the “simple chart”?
    Thank you!

    • David S on November 2, 2021 at 2:30 pm

      I believe your understanding is correct. My approach has been, for a number of years, to max out my RRSP contribution and then take the resulting tax refund and deposit it into my TFSA, and/or my non-reg investment account.

  2. Curt on November 1, 2021 at 2:25 pm

    Excellent article. I am keen to read the “now what” article. I wonder if careful estate distribution will be a consideration.

  3. James R on November 2, 2021 at 7:37 am

    Thanks for this Robb. I have been guilty of shying away from RSPs, and even though I’ve read Chilton’s book I had to go through an exercise of my own to understand why my bias is clouding my judgement.

    It’s still perspective, but I think part of my challenge is that due to a complicated tax filing it’s not as simple for me as “take the refund and invest it”. I’ll likely still need to pay tax – albeit it less tax. I definitely need to do more work on this before the RSP deadline and make sure I’m making the right choices this year!

  4. Diane on November 2, 2021 at 9:05 am

    Even before TFSA’s existed, I believed in saving $1 outside for every $1 inside my RRSP. With a TFSA this is an even better solution. I would use the tax refund to help with $’s outside. These $’s are invested in the market, mostly in items that will generate capital gains. The RRSP is invested in items that will generate interest, dividends, and capital gains. I am now retired and I can determine what my income will be by choosing where to take the $’s from. RRSP $’s are fully taxed, TFSA $’s not taxed, other outside $’s only the capital gain is taxed. I find this the best of both worlds. The one thing is that you have to be disciplined not to dip into those $’s that are outside the RRSP.

  5. Doug Brown on November 2, 2021 at 4:13 pm

    Hi Robb, I recently withdrew money from my RRSP from a direct investing account and was charged a 50.00 withdrawal fee which amounted to 1%. Is this common practice for a RRSP withdrawal or just with my particular bank? Thanks Doug

    • Robb Engen on November 2, 2021 at 4:32 pm

      Hi Doug, it’s pretty common for banks to charge this partial “de-registration” fee when making a withdrawal from an RRSP. If you’re in retirement / withdrawal mode it can make sense to convert all or a portion of your RRSP to a RRIF to avoid this fee and also avoid mandatory withholding tax on withdrawals.

  6. AnotherLoonie on November 3, 2021 at 9:49 pm

    The RRSP vs. TFSA debate is a good one, and depends a lot on your goals. Even at a high income, investing in an RRSP over your TFSA can be a mistake if you end up needing to withdrawl that money before retirement when you’ll likely be at an even higher marginal tax rate.

    My goal has been to max my TFSA first, but those tax returns from contributing to an RRSP can be too appealing to pass up. My wife, who has a pension, doesn’t really plan to contribute to her RRSP at all. I wonder if others are in a similar boat.

    • Robb Engen on November 4, 2021 at 11:28 am

      @AnotherLoonie – thanks for your comment. I’d disagree that contributing to an RRSP would be a mistake if you needed the money before retirement. In that case you’d likely be unexpectedly unemployed and so it could be perfectly sensible to draw from your RRSP at that point.

      Certainly if you have shorter-term financial goals it wouldn’t make sense to contribute to an RRSP vs a TFSA or even high interest savings account.

      Even with a pension it can make sense to contribute to an RRSP. Pension income and RRIF income (at 65) is eligible to be split with a spouse (up to 50%) so you’d have some tools to reduce your tax rate.

      • AnotherLoonie on November 4, 2021 at 1:44 pm

        Those are some great tips, Robb. I didn’t know one could split pension income in that way. Thank you.

  7. Melissa on November 4, 2021 at 7:00 am

    Great article. 1 common item missed in many articles and books is how much higher you’ll be taxed on your RRSP if you receive a pretty good pension. I never forgot what my friends dad had said regarding his RRSP. He said he wised he never contributed as he’s been taxed very high.
    Mind you I’m not even sure how he invested his RRSP when he was contributing to it. To add to that he also forgets that he receives the tax benefit when he contributed to it.
    I work for the same company and am lucky that they still have a defined benefit pension.
    I believe in purchasing RRSP’s and if you still have funds to purchase TFSA funds. Just make sure they are both invested! The first time I sat down with a certain bank personnel to open and fund a TFSA they never bothered to tell me that it had to be allocation or invested in anything. Therefore it sat in daily interest savings…. (Not for long as i got educated quickly) lol

    • Robb Engen on November 4, 2021 at 11:33 am

      Hi Melissa, thanks for your comment. I’ve written hundreds of financial plans and it is very rare to be in a higher tax bracket in retirement as you were during your working years, even if you have a pension.

      As I mentioned above in my response to AnotherLoonie, retirees have the benefit of being able to split eligible pension income (including RRIF income) with their spouse. This typically leads to a lower tax rate in retirement.

      That, and you’re often supplementing your income with cash savings that has already been taxed.

      The one thing I’ll say about retirees today is they didn’t have the benefit of contributing to a TFSA during most of their working years so the RRSP was the only tax advantaged account. Of course, as you said, they probably still forget or conveniently ignore the tax deduction they received when they contributed in the first place.

  8. Derek on November 6, 2021 at 1:44 pm

    I think people don’t think of the TFSA deposit in terms of the pre-tax contribution amount, it’s that they have a certain amount of money available, in your terms $1000 and that’s what’s going to go into one account or the other. So the calculation in their more basic terms, is if I put that $1000 in TFSA, I’ll never pay tax on it, but if I put it in RRSP, the government is coming for their 40% someday. But if you add up the contributions in the RRSP (and it takes years to finish, when you deposit that $400, the next year you get another $160, the year after $64) you’ve contributed $1666, back where you would be with the pretax amount of the original TFSA amount.

  9. Ian on November 18, 2021 at 6:35 am

    Hi. Thanks for the article. I think another important difference between TFSA and RRSP is that RRSP withdrawals are permanent (Except for certain exceptions) whereas TFSA withdrawals can be contributed again the following year.

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