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TFSA vs RRSP

TFSA vs RRSP

When it comes to saving for the future, Canadians often ask the same question: Should I contribute to my TFSA or my RRSP?

The short answer: it depends.

Let’s break it down with a simple example.

 

A Simple Comparison

Imagine you earn $15,000 and your tax rate is 33%.

  • With an RRSP, you put in $15,000. You will not be taxed on that $15,000. After growth (assuming it doubles), you end up with $30,000. But when you withdraw, you pay tax (33%), leaving you with $20,000.

  • With a TFSA, you pay tax upfront. You are left with and invest the $10,000, and it grows to $20,000. When you withdraw, you keep it all because there is no tax.

 

End result: $20,000 in both cases.

So, at first glance, it looks the same.

The Real Difference: Tax Rates Today vs. Tomorrow

The real deciding factor is your tax rate when you contribute vs. your tax rate when you withdraw.

  • If your tax rate is higher when you contribute and lower in retirement, an RRSP can be better.

 

  • If your tax rate is lower today but might be higher later, a TFSA can be the safer choice.

 

 

The RRSP Refund Trap

There’s one big catch with RRSPs: the benefit only works if you actually invest your refund.

  • In our example, $15,000 is invested directly.

  • In practice, most people are taxed and left with $10,000. And then would invest $10,000 in an RRSP where they then get a refund. That refund is supposed to go back into the RRSP.

  • But in reality, many people spend their tax refund on vacations, renovations, or everyday expenses.

  • If you do that, you’re not really ahead. Your RRSP contribution is less effective than it looks on paper.

 

A smart way around this is to file a T1213 form with the CRA. This form reduces the tax withheld on your paycheques, so you get your RRSP refund upfront and can invest it right away instead of waiting until tax time. It’s a relatively simple process, but most people don’t have the foresight to file it.

This is why many Canadians may actually end up better off with the TFSA. There’s no refund to “waste,” and your savings are more straightforward.

Why Tax Rates Are Hard to Predict

Here’s the tricky part: tax rates aren’t just about your income bracket. They’re also tied to hidden benefits and clawbacks:

  1. Pension income splitting: Up to 50% of future RRSP (RRIF) withdrawals can be taxed to your partner, who might be at a lower tax rate than you.

  2. Government benefits: Various government benefits, like Canada Child Benefit (CCB) and OAS, are reduced as you earn more income. This acts like a tax.

 

On top of that, no one really knows what their (or their partner’s) income or tax rates will look like in 20 or 30 years.

This is where a financial planner can really help. They can run scenarios based on your income, family situation, and retirement goals to guide you toward the smarter choice.

Why the TFSA Has Hidden Advantages

Even though both accounts can look the same in theory, the TFSA offers several extra perks:

  1. Flexibility: You can withdraw whenever you want, and you get the room back the next year.

  2. Room Growth: Your TFSA room grows as your investments grow in value. Combined with flexibility, this can be extremely valuable.

  3. Future Protection: Withdrawals are always tax-free, which protects you if tax rates rise in the future.

  4. Behavioural Advantage: Unlike RRSPs, there’s no refund to “accidentally” spend. This removes a major behavioural pitfall and makes it easier to stick to your long-term plan.

 

On the other hand, if tax rates go down, an RRSP might look better. But when it comes to financial planning, it’s usually smarter to protect yourself from risks (higher future taxes) than to chase potential benefits (lower taxes).

Final Thoughts

At the end of the day, both the TFSA and RRSP are powerful tools. Which one is better depends on your current and future tax rate, your other benefits, what you do with your tax refunds, and your goals.

But here’s the truth: most people don’t have a clear idea of what their tax rate will be when they retire (or even what it is today). And most people don’t reinvest their RRSP refund the way they’re supposed to. That’s why working with financial planners and accountants can be so beneficial.

Thinking about your future savings strategy? Contact CoPilot Tax today, we help you see the bigger picture. So you’re not just saving, but saving smart.