TFSA vs. RRSP: Which is right for you?
While the question is simple, arriving at the right answer for your situation can take a little thinking.
Let’s say you fall into this life bracket:
- you’re in your 30s,
- your investment generates a 5% annual investment return, and
- you’re in a 30% tax bracket during your career.
In such a case, here’s a look at what could happen under a couple of different scenarios.
What happens if you invest money in a group RRSP?
If you invest the $1,000 into your group RRSP at work, you can contribute the full $1,000 pre-tax. That’s because RRSP contributions are tax-deductible. Plus, you can get this tax deduction up front when contributing to a plan such as a group RRSP.
What happens if you invest money in an individual RRSP?
If you want to invest in an RRSP outside of a group plan, you’d:
- pay the 30% tax,
- invest the remaining $700 and
- top it back up to $1,000 with the tax refund you will receive.
What happens if you invest money in a TFSA?
If you choose to invest in a TFSA, the actual amount you’ll have to invest is $700 ($1,000 less 30% income tax). That's because you contribute to your TFSA using after-tax dollars.
To do the exact math, you’d multiply $1,000 by .30, which gives you $300. Then subtract $300 from $1,000, which leaves you with $700.
So, $700 would be the starting amount in your TFSA account. But the perk is that any investments (e.g. stocks, bonds, mutual funds, etc.) you have growing in a TFSA will be tax-free.
What happens if you withdraw money from an RRSP or TFSA before you retire?
Let’s say you were hoping to save your contribution for retirement in your 60s. But financial pressures require you to withdraw all of your savings at age 50. Per the charts below:
- Your $1,000 RRSP contribution has grown to $2,079. But because all withdrawals from an RRSP are taxable, and you’re in a 30% tax bracket. So you’re left with $1,455.30 after your withdrawal. (To do the exact math, multiply $2,079 by .30, which gives you $623.70. Then subtract $623.70 from $2,079, which leaves you with $1,455.30.)
- Your $700 TFSA contribution has grown to almost exactly the same amount, $1,455, and you can withdraw the entire amount tax-free.
While what you have in your pocket is virtually identical in either case, the one advantage to a TFSA withdrawal is that you can recontribute the full amount any time starting with the next calendar year – and there’s no loss of TFSA contribution room.
With an RRSP, you don’t get your contribution room back when you make a withdrawal. If you want to recontribute in the future, you’ll need to use unused RRSP contribution room.
What happens if you withdraw money from an RRSP or a TFSA in retirement at age 65?
If you save and invest your initial contribution until retirement, here’s what you will have when you withdraw the full amount at age 65. Per the chart below:
- Your $1,000 RRSP contribution has grown to $4,322.
- If you’re in a lower tax bracket in retirement due to a lower income (say, 20%), you’re left with $3,457.60 after your withdrawal.
- If you’re in the same 30% tax bracket, you’ll receive $3,025.40
- If you’re in a higher tax bracket (say, 40%, perhaps because you sold your home and the proceeds of the sale have generated investment income, or you’ve inherited money that has generated income), you’ll only be left with $2,593.20.
- Your $700 TFSA contribution has grown to $3,025, and you can withdraw the entire amount tax-free.