TFSA vs RRSP: Different plans for different needs

September 24, 2019

Ever since they were introduced ten years ago, Tax-Free Savings Accounts (TFSAs) have seen a rapid rise in popularity among Canadians. This is in large part due to their flexibility and the ability of savers to withdraw from them without paying any tax penalties. Some Canadians are even using them as an alternative to RRSPs. But while TFSAs are a great savings tool that can supplement retirement plans, we would be remiss to view them as an alternative to RRSPs. 


The original intent behind TFSAs was to provide Canadians with a flexible savings tool that allows them to set aside money for various short, medium, and long-term goals. Whereas the bulk of our savings tend to (or should) go towards retirement, we will always need to set aside money for things such as new vehicles, vacations, home renovations, etc. A TFSA is a great tool to do exactly that. And while they can certainly be used effectively for retirement savings, they are not necessarily a replacement to an RRSP.


Key differences


So without any further ado, let’s examine some of the key differences between TFSAs and RRSPs. The table below illustrates some of the key features associated with each plan type.



As shown above, there are some substantial differences in the way TFSAs and RRSPs operate. These differences mainly centre on tax treatment. Whereas RRSPs derive much of their popularity from the fact that contributions to those accounts reduce taxes owed, TFSAs by contrast do not offer tax savings, but withdrawing from them does not incur tax penalties as is the case with RRSPs. In that sense, TFSAs and RRSPs can be thought off as opposites. This difference in tax treatment has led many financial planners to recommend TFSAs for those with low income and RRSPs for higher earners who stand to benefit from substantial tax savings.


Advantages of a TFSA over an RRSP


There can be no doubt that TFSAs do have some advantages over RRSPs. As mentioned above, withdrawals from a TFSA do not incur any tax penalty since the plan uses after-tax contributions. This provides additional flexibility to use TFSA savings when needed. Quite significantly for retirees, income drawn from a TFSA has no impact on Old Age Security (OAS) and Guaranteed Income Supplement (GIS) payments. This has led some retirees to adopt the strategy of delaying their CPP payments to become eligible (temporarily) for GIS while supplementing their income with TFSA withdrawals. And in rare scenarios when a retiree’s income is expected to be higher that it was during their career, contributing to a TFSA makes sense.


For most people however, the appeal behind TFSAs lies in the fact they provide the opportunity to save for both short as well as long-term goals. And investing in portfolios containing some equity generally yields superior returns over those seen in savings accounts offered by banks. All these features have led Open Access to recently launch TFSAs as a useful supplement to the retirement plans our clients use.


Advantages of an RRSP over a TFSA


Whereas a TFSA can be particularly beneficial for those with low incomes, RRSPs draw much of their appeal from the material tax deductions they offer to those in middle and higher income tax brackets. And the fact that RRSP contributions can be made pre-tax means that an individual has the capacity to save more with an RRSP than with a TFSA. After all, 15% of someone’s pre-tax income is higher than 15% of their after-tax income. This is compounded by the fact that it is generally employer sponsored RRSPs, rather than TFSAs that offer matching contributions.


Another point that bears mentioning is that RRSPs, with their hefty tax penalties for early withdrawals are more likely to discourage people from dipping into their savings than the more flexible TFSAs. Indeed this is a point that is often lost on some financial planners that promote TFSAs as an alternative to RRSPs. The reality is, most of us do benefit from having built-in incentives for saving as well as disincentives for making early withdrawals, and that is precisely what RRSPs offer. This is not to say that RRSPs are the perfect savings vehicle, but they do encourage somewhat more disciplined saving for retirement.


Final thoughts


The differences between TFSAs and RRSPs demonstrates that those plans are best used to supplement each other rather than instead of the other. Whereas an RRSP is primarily focused on retirement savings, TFSAs offer us the flexibility to set aside money for virtually anything. What is clear without a doubt is we would all benefit from making greater use of these savings tools.


As a group retirement plan provider, Open Access is changing the way retirement plans are run by unburdening employees from the need to make investment decisions on their own and instead managing portfolios on their behalf. We do this as a fiduciary, meaning no proprietary products, zero conflicts of interest, and no hidden fees.

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