Should you contribute to your TFSA or your RRSP?

Both are valuable, but in certain circumstances, one may be better than the other.

Since 1957, Registered Retirement Savings Plans (RRSPs) have helped Canadians save and invest their money for retirement in a tax-efficient manner. Annual contributions to an RRSP can be used as a tax deduction, which may reduce the amount of tax a person has to pay on their income. In addition, investment income and capital gains aren’t taxed as long as the money remains in the RRSP.

Since 2009, Tax-Free Savings Accounts (TFSAs) have provided Canadians 18 years and older who have a valid Social Insurance Number (SIN) with a valuable opportunity to enjoy tax-free growth throughout their lifetime. Contributions to a TFSA are not deductible for income tax purposes.  Any amount contributed, as well as any investment income and capital gains earned in the account is generally tax-free, even when it is withdrawn.

Both RRSPs and the TFSA are beneficial, and what's best for you will depend on a number of factors. To help you decide, consider the following:

Are you saving for a long-term or short-term goal? RRSPs were designed primarily to provide for a long-term goal — retirement. Because you get a tax deduction for contributing, withdrawals are taxable unless they're made under the Home Buyers' Plan or Lifelong Learning Plan and repaid following the rules. In many cases, however, withdrawals are likely to be made when you’re no longer working and therefore are likely to be taxed at a lower rate.

The TFSA, on the other hand, has the flexibility to accommodate short-term goals more easily. While there is no deduction permitted for the contribution, any amount can be withdrawn, tax-free, at any time for any reason, subject to the nature of the investments in the account. In addition, you can re-contribute the full amount of your withdrawal in a subsequent year, except for withdrawals made to correct over-contributions.

Are you looking for an effective way to split income with your spouse or common-law partner who is taxed at a lower rate than you? The TFSA is ideal for income-splitting. You can give your spouse or common-law partner money to contribute to their TFSA and any income earned is not attributed back to you. Your spouse or common-law partner can make tax-free withdrawals at any time.

Conversely, with a spousal or common-law partner RRSP, the contributions you make to it will reduce the amount you can contribute to your own RRSP. In addition, withdrawals from the spousal or common-law partner plan will be taxed in your hands if they are made in the same calendar year or either of the two subsequent calendar years as a spousal or common-law partner plan contribution. After that point, however, both the income earned on the initial contribution and any withdrawals made by your spouse or common-law partner will be taxable in his or her hands.

Do you want to maintain your eligibility for income-tested federal government benefits? Because TFSA withdrawals do not count as income, they don't affect eligibility for income-tested federal government benefits such as the Canada Child Tax Benefit, Working Income Tax Benefit, GST credit, age credit, Old Age Security benefits, Guaranteed Income Supplement or Employment Insurance benefits.

The ideal strategy in most instances will be to contribute the maximum to both your TFSA and your RRSP in order to maximize your tax savings. If this isn't possible, then a CIBC advisor can help you decide how to allocate your contributions to make the most of both plans.

The following table outlines the primary differences between a TFSA and an RRSP.

TFSA

RRSP

Each calendar year, you can contribute up to the TFSA dollar limit for the year; unused contribution room can be carried forward. The 2021 TFSA dollar limit is $6,000.

The maximum contribution is $27,830 for the 2021 tax year or 18% of prior year's earned income, whichever is less, less any pension adjustment, if applicable; unused contribution room can be carried forward (check the previous year's T4 slip or Notice of Assessment, or check My Account with Canada Revenue Agency Opens in a new window..

No tax deduction for contributions

Tax deduction for contributions

No tax on withdrawals

Withdrawals are taxable income (certain exceptions for the Home Buyers' Plan or Lifelong Learning Plan if repaid following the rules)

Withdrawals can be re-contributed in a later year

When you withdraw money, you lose that contribution room forever

Investments may include mutual funds, stocks, bonds and GICs — just like an RRSP

Investments may include mutual funds, stocks, bonds and GICs — just like a TFSA



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