What’s the Difference Between a TFSA and an RRSP?

No matter how old you are, chances are you’re at least aware of the importance of saving for retirement via a TFSA or an RRSP. Previously, the only option available to you was to open an RRSP account (Registered Retirement Savings Plan). This meant that you could contribute a certain amount of your income each year to your RRSP account and would receive a refund cheque around tax time. It also meant that, as soon as you retired, the government would take back a huge chunk of your earnings, leaving you with considerably less than you thought you had (how much the government takes back from you depends entirely on which tax bracket you retire in – the higher the tax bracket, the more money you lose).

Recently, though, a new retirement savings option was introduced. In 2009, the TFSA (Tax Free Savings Account) was opened up to Canadians as a new way to save without the same restrictions as the RRSP.

Fundamentally, the two are mirror images of each other, but there are some concrete differences that are worth taking into account:

How Tax is Deducted

If you decide to put your money in an RRSP account, you’ll receive a tax return each year. Most people tend to spend it on something fun (a vacation, a new TV, the down payment for a new car) but the key is to put it right back into your savings! What people fail to realize is that the money they’re getting back isn’t a government handout. By spending it now, you leave yourself in a financially precarious situation later when the government deducts a chunk of your savings for tax purposes.

With a TFSA, you don’t get a cheque but your savings are left alone and untouched. The amount in your account when you finish your final day at the office is exactly the same as how much you’re entitled to keep upon making your first withdrawal.

Those Who Retire in a Higher Tax Bracket

if you retire in a high tax bracket, you’ll be hit with quite a number of tax charges. So even if you comfortably made 100k a year (and your RRSP reflects that), upon retirement it will be reduced to 70k (with the government taking back 30k).

The key is to retire strategically and ensure you retire in a lower tax bracket than during your working years. If you’re going to be taking money out of your RRSP when you’re in a higher tax bracket than while you’re working, your best bet is to go with a TFSA to prevent losing huge chunks of your savings to the government.

Those Who Retire in a Lower Tax Bracket

If you’re not currently in a high salaried job and will likely retire with a low income, a TFSA is your best bet because you’ll know that whatever you’ve managed to save up is going to stay the same (no government tax deductions). You’re also far more likely to qualify for certain government programs (the Guaranteed Income Supplement, for instance) with a TFSA than an RRSP. The lower your income, the better off you are with a TFSA.

Penalties Upon Withdrawal

If you take money out of your RRSP before you retire, you’ll be slammed with a penalty fee. No such thing exists for a TFSA. You can take money out as you please with no restrictions and no need to provide proof of what you’re using the funds for.