TFSA vs RRSP

Last week, I explained a bunch of financial jargon that you probably heard of before but had no idea what it meant. This week? We’re going even deeper! Now that you know exactly what TFSA and RRSP stand for you’re probably wondering “Ok, so what now? Which account is better for me? What are the exact differences and how do I decide which account to open first?”

(if you don’t, know what they stand for, it means you’ve missed my last post! Click here to read where I explain popular Financial Jargon)

You’re probably wondering how to build these accounts into your own money strategy. It can be confusing to make that choice. These accounts are pretty similar, in the sense that they both have some sort of tax benefits, but they’re very different in the ways in which this actually happens!

Personally, I’ve actually chosen to set up both a TFSA, and an RRSP. (I actually have 2 TFSA’s, but that’s a fun little mistake we’ll get into later in the post!)

Even financial coaches need help getting their financial sh*t together sometimes!

Alright, enough teasers! Let’s just jump right in:

The Difference between TFSA and RRSP:

The main difference between a TFSA and an RRSP comes down to taxes.

TFSA (Tax-Free Savings Account):

With a TFSA, the money you put into it has already been taxed. Therefore, when you take it out it’s NOT taxed. The additional money you accumulate through growing the account, is also NOT taxed.

Each year, when you fill out your income tax forms, you report how much you put into this account. But all the government does with this number, is track how much you put in to make sure you’re not going over your limits (remember you’re only allowed to contribute a certain amount each year) With a TFSA, your income tax is calculated the same, regardless of if you contributed to this account or not.

RRSP (Registered Retirement Savings Account):

With an RRSP, the money you put into it is NOT taxed. When you report your income tax, you also report how much you put into your RRSP’s (there’s a limit on this as well, it’s either 18% of your income or up to $26,230) The government keeps this in mind when calculating your tax return, you’re essentially telling the government: ‘treat it like I’ve made less money this year’. (It’s called ‘lowering your taxable income’)

For example, say the government taxes 20% for all people making $50,000 and under. But taxes 30% once you cross that $50,000 threshold. If you have a $55,000 salary, it means you’ll be taxed 30%. However, if you choose to contribute $5,000 of it to your RRSP. You could ‘lower your taxable income’ and go back down to the lower tax bracket of 20%

Make sense?

Another major difference is that the RRSP can only be used for retirement savings. Whereas the TFSA can be used for saving anything. ie. You can only touch your RRSP savings when you reach retirement age, versus the TFSA you can withdraw at any time. (Of course, there TECHNICALLY are ways to withdraw from the RRSP, for example there is a special credit that allows first time home buyers to withdraw up to $25,000 for their down payment, there’s also a life long learning benefit, where you can take out a certain amount for continuing education but other than these special considerations, taking money from this account before you retire causes some HEFTY penalties. It’s totally not worth it!)

Why to Choose the TFSA:

So. Why save in the ‘locked-in’ RRSP if the TFSA is an open book? As I said in my last post, the TFSA seems like a magic account. As long as you stay within your contribution limits, you can put whatever you want in it, do whatever you want with it, and take it out whenever you want!

It’s an AMAZING way to build wealth tax-free!

Buuut remember what I just said ‘as long as you stay within your contribution limits’ Each year, you’re only allowed to contribute a certain amount. From the year the TFSA became law in 2009 to 2012, the limit was $5,500. In 2012, it went down to $5,000, and then from 2013-2018 it went back up again to $5,500. In 2019, the limit has increased again to $6,000!

On top of this, the contribution limits carry over, so if you were 18 in 2009, and have never contributed anything? Your ‘contribution limit’ is a little over $60,000! (There are lots of calculators to find out what your limits are But your Canada Revenue Agency MyAccount will have your personal ‘official’ contribution limit for both accounts listed on your profile!

So, let’s assume that you suddenly get rich, OR that you were super diligent at contributing to your TFSA right when you turned 18. $6,000 a year isn’t a whole lot. Especially if you’re trying to save more than 20% of your income(that’s the most widely accepted savings rate to strive for, I’ll link my video on the 50-30-20 rule in the cards!)

Once you max out the TFSA, you sort of have to turn to the RRSP. On top of that, only contributing to a TFSA does nothing for your taxable income, You’re going to be taxed at the full and potentially high rate that you’re salary is at.

That’s totally the top advantage of the RRSP.

Why to Choose the RRSP:

Lowering your taxable income could save you tons of money depending on what tax bracket you’re in. On top of that, it’s SUPER important to start saving as EARLY as possible for retirement. Yep. The more money you put in earlier in your retirement funds, the less you have to put in later. And that’s not just saying ‘you don’t have to make up the time later’, that’s legitimately: the more money you put in now, the less money it takes in general to reach your retirement goals!

Seriously. Check out this Retirement Calculator from: Get Smarter about Money, just, input some numbers. You’ll be FLOORED by how much less you need to save. (That’s compound interest for you!)

If you make a larger wage, it might even be better for you to contribute to your RRSP. Putting money towards your RRSP is paying you. If you keep yourself at a higher tax bracket you’re paying the government. I’m all about funding social services, but wouldn’t you rather keep your money for yourself??

There’s also a third option to consider.

Why to Choose the TFSA and the RRSP

You know that hilarious taco commercial where they’re trying to decide whether they want hard or soft shell tacos, and then that little girl just says: ‘uh, why not both?!’ If you’re too young for that, wow I feel old, but that’s basically where this meme came from:

THAT’s how I feel about TFSA’s and RRSP’s. I have both a TFSA, AND an RRSP.

My RRSP, obviously, is for retirement savings. I’m pretty young. I won’t retire for a LOOOOOng time. which means my risk tolerance for investing that money is pretty high. I’ve got lots of time to make up the difference if something goes south.

However, in my TFSA, I’m saving for a house. I’d liiike to get a house, within the next 5 to maybe 7 years. Which means my risk tolerance for those investments is lower, because I’ll be needing the money sooner.If I experience a great loss with that, I’ll have less time to make up the difference. Because of these two different goals, I keep the money in separate accounts.

Now, caveat to this, yes, you CAN have multiple accounts for different things. I could have just chosen to have 2 TFSA’s but invested them differently. I didn’t choose this, because number 1 I didn’t really understand how these worked when I opened the accounts; but number 2, now that I’ve actually educated myself, I like the idea of having 2 different places to put my money with different advantages. I’m a person who likes options, and structure, I like having a retirement account that I can’t really be tempted to take money from, and one that I can take from whenever I want for whatever I need.

Now, I mentioned earlier in this post, I actually have 2 TFSA’s. This is still true. and it happened because again, when I set up these accounts, I had no idea what I was doing. I was thinking more about saving goals versus what the accounts actually did. I just knew that TFSA was a magical and good account to have. So, I opened 2 up at Tangerine bank, one labelled ‘Car’ and one labelled ‘House’.

Little did I know that you can actually open these accounts and have them sit there and do nothing. I THOUGHT I was opening investment accounts. To me, TFSA was scary, TFSA meant investment. I thought ‘I should get on this, compound interest and all that’ so I opened the accounts. But, the funny thing was, when I looked at my Mint.com account summary (I use that to track my net worth, more on that in a future post!) the accounts were in the regular account spot, not the ‘investments’ spot.

That’s how I figured out that you actually have to invest those accounts if you want them invested.

Facepalm.

I now have one of those TFSA’s moved to Wealthsimple, it’s invested and doing well. I during that time is when I opened my RRSP as well and that’s also invested, although as I stated before, it’s at a different risk rate than my TFSA. That other account I opened, still sitting doing basically nothing. It’s just a regular savings account. Yes, I need to change this, it’s kind of silly to have an account like this just collecting that measly bank interest, but I’ll get to it. Eventually… Just, being honest, I also procrastinate on things a lot!

So, how are you going to choose what account is best for you?

How to Choose - TFSA or RRSP:

Let’s do a quick summary of the benefits:

RRSP’s are great for tax rebates. If you’re at a high income then this could be a good option to hop into a lower tax bracket. RRSP’s collect tax when the money comes OUT of the account. If you know you’re going to have a lower income after you retire, this could mean you’re paying less to the government later on.

TFSA’s are taxed when the money goes IN to the account.If you’re not worried about being taxed too much, but have some extra money you want to grow, this could be a great option. TFSA’s can be used for ANYTHING. If you want to use it to save for a house, go for it. You want to use it for starting a new career, go for it. If you even want to save for retirement without using an RRSP go for it! There’s no rules on how long this money needs to stay inside the TFSA. The only limits are the amount that you can put IN the TFSA.

Also, I’m not sure if I mentioned, but you never lose this contribution room.Even if you take money out of your account, you still get that contribution room back in the following year.

This makes it a super flexible account!

Conclusion:

All in all, both accounts are really great for different reasons. If you’re just starting out, maybe start with the super flexible TFSA. Just see how you like it, you can always use that money for retirement later anyway!

Let me know in the comments do you think you’ll be opening a TFSA or a RRSP? Or, Both like me!