What are RRSPs and TFSAs?

RRSPs and TFSAs both have tax advantages that can help you achieve your financial goals. Both RRSPs and TFSAs allow your money to grow tax free. The main difference between the two is the timing of tax. The common question is: “Which one should I contribute to first?” The answer is: “It depends!”

Video transcript

When saving money, it can be difficult to figure out what the most efficient method is. One way you can lower the amount of tax you pay is by using tax effective structures. Two options in Canada are RRSPs and TFSAs.

How RRSPs work

Let’s look at how an RRSP works. When you contribute to this savings plan, the amount you contribute is tax deductible. This means that your taxable income is lower.

Suppose your taxable income is $95,000 and you contribute $5,000 to your RRSP. You now only pay tax on $90,000. The money you keep in an RRSP will not be taxed while it is in the savings plan. It is only when you take the money out of the plan that you are taxed.

RRSPs are a good choice for retirement savings. This is because they allow you to defer tax. If you’re young and working, you will likely be in a higher tax bracket than when you’re old and retired. You can benefit by deferring your tax and reducing your taxable income now in the higher tax bracket to paying it later when you withdraw the money for retirement when you’re in a lower tax bracket. Overall, you will pay less tax this way, meaning more money for you in the future.

How TFSAs work

Another option is a TFSA. When contributing to a TFSA, you don’t get a tax deduction. Much like an RRSP, your savings will grow tax-free in the savings plan. The benefit of a TFSA is that when you withdraw the money from your savings plan, you will not be taxed on this amount.

TFSAs are a good choice if you’re planning to withdraw money before you retire and are saving for something like school or a house.

The choice between an RRSP and TFSA will be influenced by what you are saving for and when you plan on withdrawing the money. With an RRSP, you will get a tax break on contributions and with a TFSA you will get a tax break on withdrawals. It all depends on what is right for you.