TFSA vs. RRSP

By Mike Howe

The TFSA vs. RRSP calculator is designed to compare investing in the 2 most popular tax-assisted investment available to Canadians.  Focusing on the potential “After-Tax Retirement Income” from each strategy, advisors can help their clients identify where they should invest.

The Tax Free Savings Account (TFSA) is an investment account that has tax free growth. In addition, withdrawals from the account are made tax free. Alternatively, deposits to an RRSP account provide a tax deduction, grow tax deferred, and generate taxable income when withdrawals are made. Since both TFSAs and RRSPs grow tax deferred and an RRSP provides a tax deduction it can be hard to figure out which investment type is best to use when saving for retirement.

Using the TFSA vs. RRSP calculator, advisors can determine what is the best course of action. Let’s look at an example for a client that is 43 and plans to retire at age 65. The following details were used  to perform this TFSA vs. RRSP analysis:

Current Age: 43
Planned Retirement Age: 65
# of Years Income Needed: 25
Rate of Return: 6.00%
Annual Contribution: $5,500
Tax Rate: Contribution Years 36%
Tax Rate: Income Years 26%

Based on this information, the calculator determines that the TFSA will get an annual contribution of $5,500 while the equivalent RRSP deposit will be $8,593.75. The RRSP deposit is larger because the $5,500 is after-tax. Deposits to RRSPs generate a tax deduction which means the $5,500 needs to be grossed-up by the tax rate in the contribution years. This larger deposit will result in the RRSP having an account balance of $395,277 at retirement compared to the $252,977 in the TFSA account.

However, since the withdrawals from each account are treated differently for tax purposes, the calculator also determines how much after-tax income can be generated. Withdrawals from the TFSA are not taxable so the $252,977 will generate $19,790 of after-tax income, while the RRSP balance will create $22,882 of after-tax income. For this client they would benefit by contributing to their RRSP over their TFSA.

The key to this analysis is the tax rates pre and post retirement. As a rule of thumb, if the tax rate is higher in the pre-retirement years than post-retirement, the contribution should be made to the RRSP account. If the tax rate in post-retirement years is higher than the pre-retirement tax rate, then the contribution should be made to the TFSA.

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