Here’s something we’d all welcome – let’s say you get a $1,000 end-of-year work bonus and want to invest it for the future. You have a personal tax-free savings account (TFSA) and a registered retirement savings plan (RRSP) at work.

The $1,000 question is: Which account do you invest it in?

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.

Let’s say you contribute $1,000* to an RRSP and it’s grown to $4,322

Your tax bracket & RRSP contribution

How much will you have when you withdraw money?

30% tax bracket, mid-career in your 30s & your RRSP has grown to $2,079.

$1,455.30

40% tax bracket, retired in your 60s with a high income & your RRSP has grown to $4,322.

$2,593.20

30% tax bracket, retired in your 60s & your RRSP has grown to $4,322.

$3,025.40

20% tax bracket, retired in your 60s with a lower income & your RRSP has grown to $4,322.

$3,457.60

*Your initial contribution of $1,000 is before taxes. RRSPs are tax-deferred. This means you don’t have to pay taxes on any money growing in the account until you withdraw funds. 

Let’s say you contribute $700* to a TFSA

Your tax bracket & TFSA contribution

How much will you have when you withdraw money?

30% tax bracket, mid-career in your 30s & your TFSA has grown to $1,455.

$1,455

40% tax bracket, retired in your 60s with a high income & your TFSA has grown to $3,025.

$3,025

30% tax bracket, retired in your 60s & your TFSA has grown to $3,025.

$3,025

20% tax bracket, retired in your 60s with a lower income & your TFSA has grown to $3,025.

$3,025

*In this case, your original contribution amount was $1,000. But since you contribute to a TFSA with after-tax dollars, your contribution of $1,000 becomes $700 after 30% income tax. 

Know your tax bracket before you withdraw from an RRSP or TFSA

In the end, the pros and cons of a TFSA vs. RRSP contribution may depend on whether your tax bracket in retirement is lower or higher than it was during your career when you made the initial contribution.

Another factor to consider is that because TFSA withdrawals are not considered taxable income, they don’t affect your eligibility for income-linked government benefits like Old Age Security (OAS). For example, in 2020, if someone age 65 had income over $75,910, some of their OAS benefit would have been clawed back by the government. And, the benefit would have completely disappeared at the $123,386 annual income level.

Many people use both RRSPs and TFSAs to save. But if you’re trying to decide which account to invest in when some extra money comes your way, consider the tax bracket you expect to be in when you hope to make your withdrawal.

You can also consider whether you’ll use key TFSA benefits such as being able to recontribute withdrawals, and not having withdrawals count as taxable income for government benefit purposes.

Need help getting started? An advisor can help put together a solid plan that suits your financial goals and needs. They can also answer questions you may have about TFSAs, RRSPs and your personal finances.

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This article is meant to only provide general information. Sun Life Assurance Company of Canada does not provide legal, accounting, taxation, or other professional advice. Please seek advice from a qualified professional, including a thorough examination of your specific legal, accounting and tax situation.