RRSP vs TFSA

It’s RRSP time, the banks coo, and you only have 24 hours left to unload your hard-earned cash. So where’s it going to go.

At one time, for most of us, the RRSP was the only tax shelter game in town. But since 2009, the Tax Free Savings Account (TFSA) is also available to Canadians who want to grow their savings, sans tax. 
 
But many Canadians still haven’t warmed to the TFSA, instead sticking with the tried and (kind of) true. So, between the RRSP and the TFSA, in a tax shelter grudge match, who comes out the winner?

RRSP Advantages
There are two main advantages over, say, a regular savings account. The first is that any income or return on investment generated within the account is allowed to accumulate without being subject to tax — at least until you start withdrawing from the account (see below). The other advantage — and in Canada, it’s unique to the RRSP — is not only do your contributions grow tax-free (to a point), but they are also tax deductible. In other words, the amount you contribute can be applied against your income, thereby reducing the amount of taxable income and, usually, lowering you tax bill.  Not too bad.

RRSP Restrictions
There are a few. First, you can only contribute 18 per cent of your previous year’s net income annually, to a maximum of $22,970 per year. (A clear disadvantage for those who earn less money, since the lower contribution limits mean that, even if you were inclined, acquiring a decently feathered nest egg is infinitely more difficult.) At one time, only 20 per cent of your RRSP holdings could be in non-Canadian investments. Subsequently, this limit was raised to 25 and then 30 per cent, but as of 2005, all RSP foreign content restrictions were eliminated.

RRSP Downside
Although the money inside your RRSP can grow without being taxed, any money that is withdrawn is taxed at your current tax rate. (Exception: the Home Buyers Plan option, which allows Canadian first time home buyers to withdraw RRSP funds to build or purchase a home — as long as the amount is paid back within fifteen years. And you can’t keep your money sheltered in an RRSP forever: by age 71, you will have to close down your RRSP. (At this point, there are other tax sheltering options available to retirees, which we’ll discuss later.)

TFSA Advantages
They’re pretty straightforward, really. You stick money in it. If it grows, you won’t pay any tax. Withdrawals are also free and clear; no penalties apply for taking your coin out. Nice, huh?

TFSA Restrictions
The 2013 maximum amount you can contribute is $5,500 annually per individual.

TFSA Downside
Unlike the RRSP, contributions are not tax deductible. Although a welcome addition to the investment scene, because of relatively modest contribution limits the TFSA can be a building block of a solid retirement plan — but in most cases, not its foundation.

And The Winner Is: Both have their pros and cons. Think of them as complimentary, not oppositional.