Is a TFSA better than an RRSP?

Before we attempt to give our insights on this argument, let us do some math to set the stage for the discussion.

If you invested $10,000 a year into an RRSP for five years and earned 5% per year then at the end of five years, you would have accumulated $58,019.13 inside your RRSP.  For argument’s sake, let’s assume you were in a 40% marginal tax bracket when you made these deposits, which in reality means you invested $6000 a year in after-tax proceeds (assuming you get a $4,000 tax refund when you file your taxes) – ($10,000 x .4 = $4,000).

So, to make the deposits equal in after-tax terms, you would only need to invest $6000 ($10,000- $4,000) year into a TFSA.  If you did this for five years and earned 5% then, at the end of five years you would have accumulated $34,811.48 inside your TFSA.

*After-tax equivalent to investing $10,000/year in an RRSP in a 40% tax bracket

Which is better?

If you were in a 40% tax bracket at retirement and you redeemed your RRSP, you would be left with $34,811.48 which is identical to the amount you would’ve accumulated inside your TFSA.

If you were in a 50% tax bracket at retirement and you redeemed your RRSP, you would be left with $29,009.56 and if you were in a 25% tax bracket at retirement and you redeemed your RRSP, you would be left with $43,514.35.

The simple mathematical truth is that if you are in the same tax bracket when you deposit and redeem your funds, the results are identical between a TFSA and a RRSP.   If you are in a lower tax bracket in retirement, then an RRSP would have been the best alternative.   If you are in a higher tax bracket in retirement, then a TFSA would have been the best choice.

From these results, you can develop some guidelines to help you make the best decision in your situation:

1. If you believe you will be in a lower tax bracket at retirement, then you should make an RRSP deposit.
2. If you believe you will be in a higher tax bracket in retirement, then you should make a TFSA deposit
3. If most of your income in retirement is going to come from government pensions, then a TFSA is probably a better option.TFSAs are not taxed, thus they do not affect income-tested government benefits.
4. If you’re saving for a short period of time, the TFSA is probably a better option. A TFSA allows you to redeposit the funds (in the next tax year) without affecting your TFSA contribution room (unlike an RRSP withdrawal).
5. If you’re saving for a house or your education, an RRSP is probably a better option if you plan on using the Home Buyers Plan (HBP) or the Lifelong Learning Plan (LLP) currently in place.

It should not be a discussion on which is better or worse but which fits your particular situation.

Clay Gillespie is the Managing Director and a financial advisor with RGF Integrated Wealth Management Ltd. The views expressed are those of the author and not necessarily those of RGF Integrated Wealth Management Ltd., which makes no representations as to their completeness or accuracy.

© Jan 2018 RGF Integrated Wealth Management Ltd. | RGF Wealth Management Ltd., Member – Canadian Investor Protection Fund.

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