RRSPs vs. TFSAs: Comparing Canada's 2 main savings plans

There is plenty of debate about whether RRSPs or TFSAs are the best place to park your savings, but financial advisers say if you understand the advantages and disadvantages of each, there is little reason not to use both.

"Both the RRSP [registered retirement savings plan] and the tax-free savings account form a very important role in an overall financial plan," explains Jared Webb, an adviser with Fernhill Financial in Victoria, B.C.

"They're both very effective.They're both fantastic tools. One is not better than the other, really. They serve different purposes. Like any tool in a tool chest, if you use the proper tool for the job, it's the most effective."

It's the tax treatment that's different, and that can make a difference when deciding which one is right for you.

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"Tax-free savings accounts and RRSPs are simply just tax strategies," Webb said. "They're just telling the government how to treat, from a tax perspective, your holding or your investment."

In the case of RRSPs, the taxes on any contributions you make are deferred until you withdraw the money — hopefully, in your retirement, when you're making less income and are in a lower tax bracket.

For TFSAs, the contributions you make have already been taxed, but you aren't taxed at all on interest or other earnings within the account. Nor are you, in most cases, taxed when you withdraw the money — although there are some exceptions.

U.S. citizens also have to be careful about using TFSAs, which are more heavily taxed in Uncle Sam's hands. Under the new rules requiring Canadian banks to report the holdings of U.S. citizens, the U.S. Internal Revenue Service is scrutinizing all the holdings of U.S. citizens living in Canada.

'A huge impact'

RRSPs, which have been around for longer and have more contribution room, hold far more of Canadians' money at the moment — just over $1 trillion in RRSPs compared to $157.9 billion in TFSAs.

There are about 14.3 million TFSA accounts with an average balance of $10,996, according to Investor Economics. Statistics Canada's latest numbers for RRSPs shows just under six million Canadians made contributions in 2013, though the numbers don't say how many people have RRSPs but didn't make a contribution that tax year. The median contribution was $3,000.

In either case, these two savings vehicles can be key tools for helping you reach your savings goals.

"The biggest expense anyone faces in Canada is taxes," Webb said. "That's the largest expense by far that we all face. So, if we can reduce or defer those taxes for as long as possible, then it has a huge impact on someone's overall financial plan and your ability to achieve what you're trying to achieve."

Webb said, ideally, people would take advantage of both plans, but he knows that's not necessarily realistic.

So. which is right for you?

Reasons to save in an RRSP:

• You want a steady stream of income from your savings in retirement: An RRSP gives you the chance to save more (18 per cent of your income to a maximum of $25,370 in 2016). This can build, with savvy investment, into a nest egg for when you stop working. "It is basically a self-funded pension plan. That's the whole intent of it," Webb said.
• You want to reduce your taxable income: Any contribution to your RRSP comes directly off your taxable income, with the potential to push you into a lower tax bracket. "If you put $5,000 into a registered retirement savings plan, they would tax you as if you had made $5,000 less that particular year," explained Michael Hlinka, a CBC business columnist and an instructor at George Brown College in Toronto. "Any gains [that] would occur have no tax implications until you withdrew the money."
• You need to put your money somewhere you won't get at it easily: It's painful to withdraw from an RRSP. There is a withholding tax that can be as high as 30 per cent if you withdraw money before retirement, which should discourage you from using your RRSP funds for a vacation or other purchase you could easily postpone.

Reasons to save in a TFSA:

• You are young and your income is low: If you are in a low tax bracket, you get less benefit from the tax-saving aspect of an RRSP contribution. But if you save the RRSP contribution room until your 30s or 40s, when you are earning more, the tax reduction will pay off. Webb said TFSAs are a good place to put money away during your time as a student or early years of working.
• An RRSP isn't an option: There are two ways that can happen. Either you've reached your contribution limit on your RRSP or you've turned 71 and are no longer allowed to contribute to an RRSP.
• You have enough coming to you later in life that you're worried about clawbacks to Old Age Security: RRSP withdrawals are considered income, so that combined with, say, a strong pension could result in a clawback on your OAS if your income exceeds a set limit ($72,809 in 2015.)

Hlinka and Webb both said that all things being equal, the RRSP is the preferred choice for long-term savings, but that it always depends on the saver's personal situation. Hlinka said anybody wanting to map out their retirement should get a financial planner.

"What I feel comfortable doing ... is to offer some generic information," he said. "But I would not go on a talk show and talk to someone for 30 seconds and make that determination that one's better than the other."