Question. Hi, I have some money that I’d like to contribute to my investment plan. I have about $110,000 in my RRSP, and about $32,000 in my TFSA. This year I can afford to contribute about $5,000, and I’m wondering if I should put it into my RRSP or my TFSA? Which one is better?

Answer. Which is better, a spoon or a fork? I guess that depends if you’re having a bowl of soup or a baked potato.

Like the “spoon or fork” question, with the “RRSP or TFSA” question, there is no universally better choice. As with so many things in personal finance, the answer is, “it depends.”

Let’s unpack that – Depends on what, exactly?

Things That Matter – Key Considerations

There are many different factors you should consider when trying to decide whether to contribute to a TFSA or RRSP account. Of course, this is relevant only to the extent that you actually haven’t reached the contribution limit for either account, and therefore you actually have a choice. Let’s take a look at some important questions to ask yourself before you proceed.

Do you want or need a tax deduction? Contributing to an RRSP results in a deduction from income. Contributing to a TFSA does not. Quite simply, if you wish to lower your taxable income so that you’ll be in a lower marginal tax rate, the RRSP is the superior choice.

What is your income? Not just your current income, but your expected income when making RRSP withdrawals (which is typically in retirement). If you’re in a higher marginal tax rate when you make an RRSP contribution, and a lower rate when you make the withdrawal, the RRSP offers an additional benefit – the taxes saved upon contribution will be greater than the taxes paid upon withdrawal. However, if your current income is fairly low, you may suffer the opposite reality – paying more tax to withdraw from your RRSP than you saved when contributing. In general, RRSP contributions are generally more beneficial to those with higher incomes, but may not be the best choice for those with lower incomes. Of course, income is entirely a non-issue with TFSAs, as contributions are not tax-deductible, and withdrawals are not taxable.

What are your sources of income in retirement? Recall that withdrawals from the RRSP are fully taxable. This is important for a number of reasons. Most other common sources of retirement income – employer pension, CPP, and OAS – are also fully taxable. Add in RRSP/RRIF withdrawals and you have a very inefficient income in retirement. Worse, your RRSP/RRIF withdrawals could cause you to lose other income tested benefits, such as OAS. On the other hand, TFSA income is entirely tax-free, is not considered income, and therefore does not jeopardize OAS or any other income tested benefits. In short, if you already have a lot of taxable income in retirement, the TFSA can help provide you with more tax-friendly retirement income stream.

When do you plan to withdraw this money, and for what purpose? Every dollar you contribute to an RRSP or TFSA has to be withdrawn at some point. Most people think of RRSPs for the typically longer term goal of retirement, and think of TFSAs for shorter term goals such as saving for a new car or a family vacation. And in many cases, that may very well be a good approach. But that certainly doesn’t mean it’s always the case. For example, many people use the RRSP Home Buyers’ Plan for the much shorter term goal of purchasing a house. And as demonstrated above, the TFSA can great for retirement savings.

Things That Don’t Matter – Irrelevant Distractions

Now that we’ve covered what does matter, let’s have a quick recap of what does not.

Types of Investments. Whatever you can buy inside your RRSP, you can also buy inside your TFSA. That is, the list of eligible investments for RRSPs and TFSAs mirror each other. Unfortunately the “S” in TFSA is a bit of a misnomer. It’s not a savings account – It’s an investment account. Perhaps TFIA would have been more appropriate, because many Canadians think of their TFSA as a savings account in the same way they think of their savings and chequing accounts. Banks often compound the problem by using language such as “TFSA rate,” which further encourages this flawed thinking. Like the RRSP, the TFSA is an investment account in which you can buy stocks, bonds, ETFs, mutual funds, etc.

Rate of return. What has a better rate of return, a TFSA or an RRSP? That’s kind of like asking, “What kind of car is faster, red or blue?” It’s a nonsensical question. Neither an RRSP nor a TFSA has a rate of return. That’s because they are accounts, not investment products. Think of RRSPs and TFSAs as baskets – the baskets can hold many different types of investments, and there are are special tax rules for when those investments are moved in and out of the baskets. The rate of return earned in an RRSP or TFSA is determined by the investments purchased inside those accounts. But until those investments are purchased, the accounts themselves are like empty baskets, and have no rate of return.

Strategy – Why not do both?

Of course, everyone’s situation is unique, and this isn’t intended to be a specific recommendation for anyone in particular. But here’s a potential strategy to consider – why not contribute to both?

Example

You’re in a 40% marginal tax rate. You have $5,000 to contribute. You decide to contribute the entire $5,000 to your RRSP. This results in a $2,000 tax refund (since you’re in a 40% marginal tax rate). You then contribute the $2,000 to your TFSA.

Presto! You only had $5,000 to begin with, but now have ended up with a $7,000 total investment contribution. Better yet, you didn’t have to pick between the RRSP and TFSA – you’ve contributed to both.

Bottom Line

So, should you contribute to your RRSP or TFSA? As we’ve seen, there really is no correct answer. More importantly, it’s not even a good question to begin with. You can contribute to both – it doesn’t have to be one or the other. Obsessing over which one is better is largely a distraction, and can often lead investors to become paralysed with indecision and make no investment at all.

Before making your decision, ask yourself the questions outlined above. That should help you make a more informed decision, and help you decide which course of action makes the most sense for you. And if you’re still not sure, just ask us.