When to Use a TFSA vs. an RRSP

Registered investment accounts are an important tool to save for your long-term goals. These four factors can help you figure out when to use a RRSP and a TFSA.

With so many registered investments accounts at your disposal, it can be hard to know which one to use first. That's often the case with the Registered Retirement Savings Plan (RRSP) and Tax-Free Savings Account (TFSA) – two tax-advantaged accounts that many people use to save for their long-term goals.


These four factors can help you better use your registered investment accounts to fund your goals. 



Your income, today and tomorrow 


Many investors feel inclined to use the RRSP first. That's because the tax advantage of an RRSP is very much front-loaded, with 100% of your contributions getting deducted from your taxable income, which could result in a tax refund. But the answer to where to invest first is not that simple. It often depends on how much you're earning today and how much you think you might earn later in life.


The RRSP is designed to help you lower your tax bill during your highest-earning years. When you're in a high tax bracket, your contributions could drop you into a lower tax bracket, which could help you get a sizable tax refund. In retirement (which is when most Canadians withdraw from their RRSP), you may be in a lower tax bracket, meaning you’ll pay less tax on your income. If you're still earning a higher income your retirement years, you may need advanced tax planning from a tax professional to ensure that the taxes you owe won't be more than you may have anticipated. 


Because you don’t get any up-front tax deduction for contributing to a TFSA, any investment gains, interest or dividends are  generally tax-free when you withdraw. You can invest for any purpose and remove funds at any time. It's important to talk to a Financial Advisor about the right type of investment account for you.



Decide what you're saving for 


As its name suggests, the RRSP is meant for one purpose – to provide an income stream in retirement. There are some exceptions, such as removing money tax-free to buy a home, but you have to pay those funds back. Generally speaking, the RRSP is intended to help you save for your golden years. That makes choosing between the TFSA and RRSP simple: If you're saving for retirement, consider the RRSP first.


Because RRSP withdrawals are taxable as income, it may not make as much sense to use them to fund other purchases or goals. With a TFSA, withdrawals are not taxable, so the account can be used to save for short- and long-term goals, such as saving for a down payment, home renovation, vehicle purchase, or even a dream vacation.


Many people use TSFAs as a method for saving for retirement. However, their contribution limits only increase a set amount each year (i.e., $6,500 in 2023) and are generally capped lower than an RRSP, which is the lesser of 18% of your earned income in the previous year or the annual RRSP limit set by the Government of Canada. You can potentially save a lot more for retirement in an RRSP.   



Think about what you want to hold 


Another benefit of the TFSA and RRSP is that you can hold many types of securities in both. That includes guaranteed investment certificates (GICs), stocks, bonds, mutual funds and exchange-traded funds. Unlike non-registered accounts that tax interest income, dividends and capital gains in the year you earn them, registered investment accounts help prevent you from getting an investment-related bill from the government at the end of every year. 


What you decide to hold in each type of account will depend on your goals. Generally, shorter-term savings are held in more conservative investments, as you don't want a market decline to reduce your portfolio's value. Longer-term investments, such as retirement savings, have many more years to grow after a down period, so you could put those dollars in more aggressive securities. Consider your circumstances and talk to a Financial Advisor to help you decide the optimal investments for each account.  



Consider using both 


When it comes to deciding between an RRSP and TFSA, it’s not an either-or question – you can use both. If your income and savings goals suggest using an RRSP first, consider the TFSA after maxing out the RRSP. If you're saving for a shorter-term need in a TFSA and have money left over after reaching your goal, consider putting the additional funds into your RRSP. What you can invest will depend on your available contribution room – the total room is on your annual Notice of Assessment – and the extra cash you have available to invest.


Ultimately, TFSA vs. RRSP isn’t so much of a debate as it is a careful determination. What are your goals? What is your time horizon and appetite for risk? Talking to a Financial Advisor can help you maximize both types of registered investment accounts.

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