An RRSP or a TFSA? How to Find the Best Savings Account For You

An RRSP or a TFSA? This is the time of year when that question pops up. It seems like every time you walk by a bank or log on to online banking, you find ads about making a registered retirement savings plan (RRSP) contribution before the March 1st deadline or making your 2017 tax-free savings account (TFSA) contribution.

While it would be nice to maximize a contribution to both a TFSA and an RRSP, most of us don’t have the ability to do so, which brings us back to your original question: “Which is a smarter strategy?”

Before we can answer that, we need to look at how each account works.

What’s an RRSP?

With an RRSP, you can contribute 18 percent of your salary each year up to an annual limit (the 2016 limit is $25,370). The short-term benefit with an RRSP is that you get a tax deduction for making a contribution. The long-term benefit is that your money grows tax-free while it remains in an RRSP.

The drawback is that when you withdraw funds from your plan, the money is added to your annual income and taxed. Also, after the age of 71, you will have to withdraw a certain percentage each year, even if you don’t need the money. Lastly, once you take money out of your RRSP, you can’t recontribute to it.

What’s a TFSA?

With a TFSA, you can contribute up to $5,500 each year. Unlike an RRSP, though, this contribution is not tax deductible. However, your money grows tax-free while it remains in a TFSA.

When it comes to withdrawals, a TFSA is much more flexible than an RRSP: Withdrawals from a TFSA are tax-free, you aren’t required to withdraw from a TFSA if you don’t need to, and you’re able to recontribute any TFSA withdrawals during the next calendar year.

So, to go back to your original question, should you contribute to a TFSA or an RRSP? While the answer depends on each person’s unique circumstances, there are some general guidelines you can follow.

The Best Savings Account For You

If you think you’ll need the money in the next couple of years for a car purchase, a home renovation, an emergency fund or a family vacation, a TFSA is the better option because of its greater withdrawal flexibility.

An RRSP is the better choice if you are in a higher tax bracket now but expect to be in a lower one in retirement. The math behind this is that you’ll get a nice tax refund for contributing at a higher tax rate today while paying at a lower tax rate when you withdraw funds during retirement.

If you don’t think your tax rate will change in retirement, a TFSA may be the better choice. The rationale is that the tax refund you would get from an RRSP contribution today would be identical to the tax you would have to pay on withdrawal in retirement. Noting this equivalence, a TFSA may be more attractive given the fewer rules regarding withdrawals.