TFSA or RRSP? A 2024 chat about what to do!

It's that time of the year. A new year gives us opportunities to invest either using a TFSA or using your RRSP.  Personally I think it's a confusing matter for most people so let me try to help. 🙂

In this blog post, I will share my experience and thoughts after years of debating what to do with these great tools. It's not financial advice, just sharing how I see them, in case it helps you out.

Here's the 'What I would do' section of the blog post

I will explain my reasoning in a concise manner later in this post. However I chose to put the summary at the start in case you don't want to read a lot and just want the answer.

• People usually earn lower income during their younger years. For example:
• An intern would earn less than
• ... a junior staff who would earn less than
• ... a senior staff with years of experience...
• You see where I am going with this. This is right in most cases.

• Based on this assumption, here's what I would do:
• I would always tell someone who is in the first 10 to 15 years of their career to only invest using the TFSA.
• When they hit the 15 year point they should begin dipping their toes into RRSPs.
• A strategy that could work is maybe start by investing just a little, then increase it slightly year over year.
• At the 25-30 year mark of their career, they should gradually shift focus to having most of their investments go into RRSPs
• At the 30 year mark, I'd recommend all their longer terms investments go into RRSPs.
• To recap, my examples assumes a person is progressing and getting more income as their go through their career.

• Note: If they have their TFSA's contribution room maxed out, then they might consider RRSP, even so, I would tell them to defer claiming the RRSP benefit for a few years when filing taxes.
• Deferring redeeming the RRSP benefit when filing taxes would allow them claim it in later years, where hopefully they are earning more salary and are in higher tax brackets. This would give them more money back.

Let me try to make sense of my above comments, as briefly as I can

There are tons of articles that explain this well, and in a lot of detail, but I find myself overwhelmed and confused at the end, so here's my brief take on these tools:

TFSAs and RRSPs both are tax sheltered financial instruments to help you save money on taxes. However there's no escaping that in almost all cases, you do have to pay taxes at some point. This makes it important to understand what these tools do! 

TFSA

It's a tool to help invest where:

• You prefer to never have to pay any taxes after you invest your money.
• i.e. you like to have your investment grow as much as it can.
• Then when you withdraw it, you don't pay taxes on it!
• You don't pay any 'yearly taxes' for your investments, there are no tax forms when you do your taxes.
• The catch or gotcha is that, you have paid your taxes upfront for the money you are going to put in your TFSA, when you earned it from your job.
• What I mean is, if you're paid $1,300 from your job for your paycheque, then after the payroll deductions you have $1,000 in hand. (assuming a 30% tax rate)
• Assume we are going to put this whole paycheque (at least the after tax part of it, $1,000) into our TFSA.
• Then, anything you do within the TFSA (within it's rules) goes tax free, forever!

I know it's confusing, let me give you an example to help clear things up:

• You get your paycheque where you're paid $1,300 from work.
• The paystub shows your usual deductions like EI, CPP and Taxes.
• You're left with $1,000.
• Now you have enough saved up so you can put the whole $1,000 into your TFSA.
• Let's say it's a stock trading TFSA account like WealthSimple's one.
• You then buy some good stocks to invest for the coming years.
• 10 years ago by and lets say your stocks tripled, making the investment worth $3,000.
• You then sell the shares and withdraw the money.
• Result:
• When you do sell, there are no penalties, taxes to pay, you just get the cash in your hands. Period.
• You end up with $3,000 in cash for this example.

RRSP

This tool helps because:

• When you put in money into an RRSP (i.e. your contribute money into your RRSP account and claim it on your taxes), then you don't pay your income taxes for that amount of your income you've invested in. (I'll explain in an example below...)
• Just like a TFSA, you don't pay income taxes to the Canadian Govt. on a yearly basis on your investment earnings.
• The gotcha in this scenario is; when you withdraw the money from your RRSP, you're going to be taxed! Ouch, lol.
• The easiest way to explain it is; the amount you withdrew is just like earning overtime from work.
• So you have to pay income tax, just like if you earned that amount of money doing extra work.
• This means you will have a reduced amount left at the end of the withdrawal process.
• It's not all bad, see the scenarios below for how this actually helps!

I am going to do two scenarios in the below example to help explain this in a more useful way:

Example

• You earned $1,300 on you paycheque and after the usual deductions like EI, CPP & Taxes, your left with $1,000 just like the TFSA example above.
• i.e. you're earning just about enough to get you into the 30% tax bracket.
• Also like the above example, you decide to invest it all.
• Again, you buy $1,000 worth of shares in a company.
• You now file your taxes and claim your RRSP contribution.
• You should now get about $300 back extra in your tax refund.
• This effectively gives back the money you paid in taxes on your paycheque.
• Let's say you re-invest as well, back into the RRSP to top up your investment to $1,300. 
• Now like in the last example; in 10 years your investment triples, however since you have more money invested in this example, you have $3,900 of shares, $900 more than the TFSA example.
• Now you want to withdraw the money, here's where it gets interesting:

Scenario 1

• 10 years have gone by, you've got one, or two promotions. Yay future you!
• Because you're now earning more money, you've moved up tax brackets and are being taxed at 40%. It's an amazing problem to have!
• This means when it comes time to sell the shares and withdraw the $3,900 from the RRSP, you have to pay up 40% of it as taxes. Ouch!

Result: You end up with just $2,340 in cash for this situation

Scenario 2

• 10 years have gone by, but you've retired a year to two ago, or you've stopped working.
• You just have a little income coming from pension plans and/or the govt (e.g. EI/CPP maybe). So let's assume you're earning enough to place you in the 20% tax bracket to make this a fair example.
• This means when it comes time to sell the shares and withdraw the $3,900 from the RRSP, you only will end up paying 20% of it as taxes.

Result: You end up with at least $3,120 in cash for this situation. Not bad.

Conclusion

RRSP

• You effectively don't pay any tax between your income to your investment. This lets you invest a bit more upfront.
• However, you pay taxes when you sell your investment and withdraw the funds.
• So:
• Contribute/Claim it on your taxes in your higher income years.
• Withdraw from your RRSP in your lower income years.

TFSA

• You pay taxes upfront (we all pay these taxes when we get our paycheque, nothing extra).
• Then, you never pay taxes on that again as the investment is truly sheltered from any further taxation.
• So:
• Contribute to your TFSA in your lower income years.
• Withdraw from your TFSA in your higher income years.

I've just attempted to help you see the difference between TFSAs and RRSPs. That's the only goal of this article.

I also hope you see how both are amazing and powerful tools, that work well at different stages your your life/career.

You should know there are rules, e.g. how much you can invest, types of investments, etc. I won't be putting them in here (at least in this post) since that's easy to find on the internet.

I will be putting in more details about TFSAs and RRSPs later.

Update: I have created an article about how to invest with RRSPs and TFSAs just now.

Let me know if there's something you want to know in the comments and I will try to help you out, or make a quick blog post about it accordingly.