Not sure whether to select an RRSP or a TFSA? It’s a very common question that arises, as many Canadians don’t know the difference between the two.

Essentially, both the Registered Retirement Savings Plan (RRSP) and the Tax-Free Savings Account (TFSA) let you shelter your investment returns from taxes. Both have their pros and cons, and whether you choose an RRSP, a TFSA — or in some cases both — depends on your needs and circumstances.

Here’s a breakdown of how RRSPs and TFSAs work, how they differ from each other, and how each could best match your goals.

1. What is an RRSP?

An RRSP is an account intended to help you save for retirement, and the contributions made result in immediate income tax deductions in the year you contribute.  One of the main benefits of an RRSP is that you defer paying taxes on the money you put in today and any investment income earned, until years later when you withdraw your money in retirement. When you’re retired, you could potentially be in a lower tax bracket and pay fewer taxes than when you are making a larger income.

2. What is a TFSA?

TFSA is a relatively new investment vehicle that was introduced in 2009. It can be used to save towards retirement, but also many other goals because, unlike an RRSP, you’re free to withdraw at any time without penalties. The main benefit of a TFSA is that they are completely tax free. Since you’ve already been taxed on the money you put into your TFSA,  any income you earn from the investments within your TFSA are completely tax free, even when you withdraw from it.

3. What type of investments can I hold in an RRSP or TFSA?

Generally, the same types of investments are permitted in both. There are a wide variety of options to choose from including cash, guaranteed investment certificates (GICs), exchange-traded funds (ETFs), mutual funds, stocks and bonds.

4. Is there an age requirement?

You must be 18 years of age or must have reached the age of majority in your province and be tax resident of Canada, to open a TFSA and make a contribution. . However, for an RRSP, you can open and contribute as soon as you start earning income.

In order to contribute to an RRSP or a TFSA you need a Social Insurance Number.

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5. When can I withdraw my money from an RRSP?

You can withdraw money from your RRSP at any time but it will be subject to withholding and will also be taxed as income.

6. Can I withdraw money from my RRSP without paying taxes?

RRSP withdrawals are usually taxed as income. But there are two exceptions:

  • The Home Buyer’s Plan (HBP): The HBP allows you to borrow up to $35,000 tax-free from your account that you can put towards your first home. You have 15 years to pay it back without any penalty.
  • Lifelong Learning Plan (LLP): The LLP allows you to borrow $10,000 a year to help pay for your education. You have 10 years to pay back this amount without any penalty. You can also use the LLP for your spouse’s education, but not for your children.

7. When can I withdraw from my TFSA?

You can withdraw from your TFSA anytime, depending on the type of investment, without being taxed. An important rule to be aware of when withdrawing from your TFSA, is that making a withdrawal doesn’t result in loss of your lifetime contribution room. Withdrawals you make will be added to your unused contribution room the following year. Next year, you can contribute next year’s limit plus the amount you withdrew this year.

8. Is there an age limit to make the contributions?

RRSP contributions can be made up to and including Dec 31 in the year when you turn 71 or in the case of spousal RRSP up to the year when your spouse turns 71.

For a TFSA account, you must be at least 18 years of age, but you can continue investing as long as you want.

9. I over contributed to my RRSP and TFSA. What happens now?

The over contributions towards TFSA will be subject to a penalty of 1% per month. This is only on the over-contribution amount.

For an RRSP account, you can exceed the contribution limit by $2,000 without penalty after which a penalty of 1% per month will apply.

Another important factor to keep in mind is how your income and goals can affect the investments you choose. For example, those in a lower tax bracket may benefit less from the tax savings an RRSP provides and could be better off contributing to a TFSA now. However, if income rises in future years, you may want to start contributing to an RRSP.

You might choose one plan over the other or choose to contribute to both, but as your income increases or if there are significant changes in your life then you will have to tweak the strategy and contributions to get the most bang for your buck. 

Want to talk about which investment option is right for you? A Scotiabank advisor can help.