Should you contribute to a Tax-Free Savings Account (TFSA) or a Registered Retirement Savings Plan (RRSP)? For many people, the answer depends less on which account offers “tax-free growth” and more on when they expect to pay tax.
With a TFSA, you contribute money on which you have already paid income tax. Investment growth and withdrawals are generally tax-free. An RRSP contribution can reduce your taxable income; investments generally grow without annual tax inside the plan, but withdrawals are taxable income.
Consider Maya, an Alberta resident with $6,000 available to save after tax. Assume her marginal tax rate is 30% when she contributes and when she withdraws, and that she earns 5% annually for 25 years.
| Comparison | TFSA | RRSP |
| Amount invested | $6,000 | $8,571 |
| Tax savings from contribution | $0 | $2,571 |
| Value after 25 years | $20,318 | $29,026 |
| Tax on withdrawal at 30% | $0 | $8,708 |
| Amount Maya keeps | $20,318 | $20,318 |
Figures are rounded. The $8,571 RRSP contribution has a net after tax cost of $6,000, assuming Maya can use the full deduction and has sufficient RRSP room. The example assumes the same investment return in both accounts and excludes fees.
The comparison works only if Maya invests the equivalent amount. If she puts just $6,000 into her RRSP, she may receive $1,800 in tax savings, but that refund is part of the comparison. Investing it and the tax savings generated by any further RRSP contributions, moves her toward the $8,571 contribution shown above. If the refund is spent, she has invested less for retirement than in the equivalent example.
The refund can also serve another deliberate purpose, such as paying down high interest debt, contributing to an RESP or building a TFSA. The right choice depends on the household’s full financial picture.
The RRSP tends to be more attractive when the tax rate saved on contribution is higher than the tax rate paid on withdrawal. An RRSP deduction can also lower the income used to calculate benefits such as the Canada Child Benefit. A TFSA may be more useful when you expect to face a higher tax rate later, need flexible access, or want withdrawals that generally do not affect federal income tested benefits.
Here is the same comparison when Maya receives an RRSP deduction at a 30% marginal tax rate but pays tax at only 20% when she withdraws the funds. The TFSA assumptions remain unchanged: $6,000 invested after tax, 5% annual growth and a 25-year holding period.
| Comparison | TFSA | RRSP |
| After-tax amount available | $6,000 | $6,000 |
| Contribution tax rate | Already paid | 30% |
| Amount invested | $6,000 | $8,571 |
| Value after 25 years | $20,318 | $29,026 |
| Tax on withdrawal | $0 | $5,805 at 20% |
| Amount Maya keeps | $20,318 | $23,221 |
| RRSP advantage | — | $2,903 |
Figures are rounded. An $8,571 RRSP contribution produces $2,571 of tax savings at a 30% marginal rate, leaving the same $6,000 net after-tax cost as the TFSA contribution. Because the RRSP withdrawal is taxed at 20%, Maya keeps about $2,903 more than with the TFSA in this illustration.
For business owners, the decision also belongs alongside questions about compensation, cash needed in the business and investing within a corporation. Those choices deserve their own analysis; there is no permanent rule that one account should always come first.
Wondering where your next dollar should go? Contact the KBH Wealth Planning team to review how your TFSA, RRSP and corporate savings fit together.
This illustration is for educational purposes. Tax rates, contribution room, benefits and withdrawal timing vary by person.