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Comparing TFSAs and RRSPs

Canadians need to change their view of Tax-free Savings Accounts (TFSAs) from a short-term emergency fund to a long-term investment account. The long-term benefits offered by TFSAs far exceed those currently offered by Registered Retirement Savings Plans (RRSPs) and Taxable Investment accounts.

 

 

One of the most important characteristics of a TFSA is its ability to accumulate investment income free of all taxation. You earn your income, pay your tax on that income, invest within a TFSA and never have to pay another dime of tax on your savings or the income it earns. What could be better?

The following tables summarize the basic differences and similarities between TFSAs and RRSPs:

 

 Comparison of Differences

 Tax-Free Savings Accounts (TFSA)

Registered Retirement Savings Plans (RRSP)

 Contribution Limits:

The total of $5,500, plus Withdrawals made in the previous year, plus Unused contribution room from previous years.

18% of the previous year’s earned income to a maximum $25,370 for 2016 ($26,010 for 2017), plus Unused contribution room from prior years.

 Deductible Contributions:

Contributions are not deductible from taxable income.

Contributions are tax-deductible.

 Minimum Age for  Contributions:

Minimum age limitation is 18 years of age.

If you have Earned Income, no minimum age limit.

 Maximum Age for  Contributions:

No maximum age limit.

Maximum age for contributions is 71 years of age.

 Withdrawals:

Tax-Free.

Taxable.

 Investment Income:

Tax-Free

Tax-Deferred

 Re-Contribution of  Withdrawals:

Yes. Withdrawals are added to the account holder’s unused TFSA contribution room in the following year.

No. Withdrawals cannot be re-contributed unless you have unused contribution room.

 Government Benefits Impact:

Withdrawals are not included in your taxable income and, therefore, have no impact on entitlement to government benefits.

Withdrawals increase your taxable income and, therefore, may reduce your entitlement to government benefits.

 Spousal Plans:

Not permitted. But you can contribute to your spouse’s TFSA.

Permitted.

 Joint Accounts:

 Not Permitted

 Not Permitted

 Corporate Accounts:

 Not Permitted

 Not Permitted

 Plan Maturity:

 

No maturity date.

Plan matures on December 31 in the year the holder turns 71 years of age.

 Taxation Upon Death:

 

 

The account’s fair market value on date of death passes on tax-free.

RRSP’s fair market value is included in the deceased’s date of death tax return and taxed at the marginal tax rate, unless the plan names a surviving spouse as the beneficiary.

 Creditor Protection:

 

None.

In the event of bankruptcy, the RRSP assets are protected from creditors.

The similarities between a TFSA and RRSP account are fewer and a brief summary is listed below:

  • Contributions to both plan types can be invested in the same investments.
  • Earnings inside both types of plans are not taxed.
  • Account holders can plan for the transfer of their plan assets, upon their death, by designating a beneficiary.
  • Realized Capital Losses within both plan types cannot be deducted against taxable capital gains.
  • Holders of both account types will pay a tax penalty on over contribution amounts.
  • Unused contribution room can be carried forward for use in future years.
  • Canadian residents can only open both TFSA accounts and RRSP accounts.
  • Both a TFSA and a RRSP are excellent savings vehicles for the accumulation of long-term investments and retirement assets.

To illustrate the long-term benefits of accumulating retirement savings within a TFSA, we have used the InvestingForMe Taxable vs. Tax Advantaged Investments calculator to generate the following comparisons in Table 2 and 3.

Table: Comparing the value of $15,000 deposited into a Taxable, a Tax Deferred, and a Tax-Free account. The calculations assume an annual 4.0% investment rate of return, no additional contributions and the funds are withdrawn from each account at the end of ten years.

Income Tax

Rate

Taxable Investment

Account

Tax-Deferred

Investment Account

(RRSP)

Tax-Free 

Investment Account

(TFSA)

30.00%

$20,324

$16,164

$23,092

35.00%

$19,894

$15,010

$23,092

40.00%

$19,471

$13,855

$23,092

 

Table: Comparing the value of an initial $15,000 deposited, and annual contributions of $5,000, into a Taxable, a Tax Deferred and a Tax-Free account. The calculations assume an annual 4.0% investment rate of return and the funds are withdrawn from each account at the end of ten years.

Income Tax

Rate

Taxable Investment

Accounts

Tax-Deferred

Investment Account

(RRSP)

Tax-Free

Investment Account

(TFSA)

30.00%

$80,344

$81,093

$88,021

35.00%

$79,133

$79,939

$88,021

40.00%

$77,940

$78,784

$88,021

 

Note: The contributions to the Tax-Deferred Investment Account are tax deductible when they are made. The calculator has increased the contribution amount for the tax deferred investments by the amount required to make the net contribution equal to the contributions made on an after-tax basis. The income tax rate is assumed to be the same when contributions are made and withdrawn.

In addition, investors should keep in mind that the calculations do not consider the different types of investments that receive preferential income tax treatment (for example, dividend and capital gain income, which are taxed at a much lower rate than interest income and monies withdrawn from a Tax-Deferred account (RRSPs)). The lower income taxes on capital gains and dividend income would make the Taxable and Tax-Free Investment accounts more attractive than the Tax-Deferred accounts.

 

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