You needed to save and invest for retirement, so you open an RRSP and contributed as much as you can each year.

Sure, the saving part is tough. And, of course, investing always had its challenges. But at least, we all know that an RRSP is the easiest way to invest for our future. We do this because government advises us that we should.

Then in 2009, along came the TFSA – tax-free savings account. This was started by the government to give those who had maxed out their RRSP contributions another place to invest. But did they really need a place to put another $5,000? No! But it was a government handout during an election campaign to serve the 4% of the population that wanted more room in their investment portfolio.

Most of the population are probably going to have to prioritize how they invest for their future. They will have to figure out which vehicle is right for them to focus their investment dollars. When you make an RRSP contribution, you get to deduct that amount from your taxable income. The investments inside your RRSP grows on a tax-deferred basis as long as they stay in the plan. Meaning when money is withdrawn directly from the RRSP, or from the registered retirement income fund (RRIF), or an Annuity to which the RRSP has been converted will be taxable.

Let’s say you have invested your money and your RRSP has grown to $1,000,000, that’s a nice size portfolio. You have worked hard to establish that piece of your financial security for retirement. But did you know that you also have a partner – the government – who is waiting patiently for their share!  As we stated above when you start to withdraw on your investment you will be taxed at the rate of your tax bracket.

A TFSA is the mirror image of an RRSP. Although you contribute after-tax dollars. So you don’t get a deduction for your contribution. But once the money is in the plan, it not only grows free of tax but also comes out free of tax. No tax is ever paid on this investment!

So why are we all not investing in a TFSA? There is definitely a circumstance that allows for either investment, you have to know which one will suit you best from a financial standpoint.

To help you understand the federal government introduced TFSAs, and created Chart 1:

Pre-tax Income $1,000 $1,000
Tax $ 400 N/A
Net contribution $ 600 $1,000
Value 20 years later @ 6% growth $1,924 $3,207
Tax upon withdrawal (40%*) N/A $1,283
Net withdrawal $1,924 $1,924
* The marginal tax rate — the rate of tax charged on the last dollar of income

This chart shows how a TFSA contribution is made with after-tax dollars while withdrawals are tax-free. And an RRSP contribution is made with pre-tax dollars  while withdrawals are taxable.

The chart also demonstrates that if you are in the same tax bracket when  you contribute and nothing changes and you remain in the same tax bracket at the time of withdrawal, then TFSAs and RRSPs work out to be the same. This is really simplified math and generally not the case for many investors. But it does show how these investments work in  its easiest form.

What you should know is if your tax bracket is lower at the time of withdrawal than at the time of contribution, the RRSP will win. But, if your tax bracket is higher at the time of withdrawal than at the time of contribution, the TFSA will win. The fluctuation in tax brackets is the tricky part; the perfect scenario is to be in a lower tax bracket during your retirement years.

Most of us contribute to RRSPs with after-tax savings and then spend the refund. We talked about this before in another article and it is your money to spend. Although if you invest that refund in yourself what would happen?


See the Chart 2 below:

Contributed after-tax savings $1,000 $1,000
Value 20 years later @ 6% growth $3,207 $3,207
Tax upon withdrawal (40%) N/A $1,283
Net withdrawal $3,207 $1,924

Now that’s a savings but remember this was after tax money that came from a refund and   was deposited into savings… yes, it was free money from your tax return and the initial investment into an RRSP. This shows how to use tax-free money (your refund) to your advantage keeping it tax-free moving forward.

So which investment is right for you?

TFSAs are very flexible. You can take money out of a TFSA at any time and then put it back in future years. We see this vehicle as investment portfolio for someone who is investing $5,000 or less into his or her plan a year. In other words, if you are in a low tax bracket then you may be better off with TFSA because you are not benefiting from the tax deduction.  A TFSA will be more fitting for your situation and you will not have to worry about being hit by the taxmen at retirement.

The RRSP investment is for the person who wants to lower their taxable income and is trying to invest 10% or more of their earned income into a retirement plan. As stated above the money will grow tax deferred within the RRSP until the funds are withdrawn. If you receive a tax refund that money can be used to build an alternative investment portfolio. As we have seen from chart 2 above, take your return and invest it into a TFSA you will be further ahead in the future. That alternative investment will grow tax-free and will not be taxed on withdrawal.

There is no wrong or right answer on which way to go when investing for retirement. The key is to have a plan moving forward and to stick with that strategy so that you can create a solid financial plan.

Many Canadians who are using TFSAs as retirement-savings vehicles are going to have trouble avoiding the temptation to withdraw from their plans. Many will rationalize the need to withdraw from their future retirement savings for the pleasure of spending it on something they want now. With an RRSP, the threat of paying tax on your withdrawal is a deterrent as no one wants to pay tax to the government so they can buy that must have item. Retirement planning will require some restraint and understanding when using a TFSA and savings vehicle.

Finally, some advice that will serve you well:

  • If you choose to invest in RRSPs, don’t spend your refund; Invest in yourself!
  • If you choose to invest in TFSAs, don’t spend your TFSA;
  • Whatever investment you choose, save more than you are today by trying to increase your investment dollar on a yearly basis!

Above are ideas, which may help you decide which plan is right for you, as always we at Henley Financial & Wealth Management are here to help.

You may also contact us at the following  with any questions or thoughts you may have regarding investing in your future.


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