For most people in Canada, the choice between a Tax-Free Savings Account and a Registered Retirement Savings Plan comes down to three questions: what tax rate you pay now, what rate you expect to pay when you take the money out, and when you might need it.

How each account is taxed

An RRSP gives you a tax deduction when you contribute. The money grows without tax while it stays in the account, and every dollar you withdraw is added to your taxable income in the year you take it out.

A TFSA gives no deduction when you contribute. The money grows tax-free, and withdrawals are tax-free too. Anything you withdraw is added back to your contribution room at the start of the next calendar year.

The tax-rate test

If your tax rate when you contribute is higher than your tax rate when you withdraw, the RRSP usually comes out ahead: you save tax at a high rate and pay it back at a lower one. If your rate is likely to be the same or higher when you withdraw, the TFSA usually wins, because its withdrawals are never taxed.

This is why people in their highest-earning years often lean towards the RRSP, and people early in their careers, on lower incomes, often lean towards the TFSA. Their deduction is worth less today than it may be later.

The timing test

Money you may need within a few years generally fits better in a TFSA. You can withdraw it without tax and recontribute later. RRSP withdrawals are taxed, and except for specific programs such as the Home Buyers’ Plan, the contribution room used is not restored.

Other things that tip the balance

  • Workplace matching. If your employer matches contributions to a group RRSP, that match is usually the first place to save.
  • Income-tested benefits. RRSP and RRIF withdrawals count as income, which can reduce benefits such as Old Age Security for higher-income retirees. TFSA withdrawals do not.
  • A first home. If you are a first-time buyer, the First Home Savings Account may come before either, because it offers a deduction going in and tax-free qualifying withdrawals.
  • Discipline. The RRSP’s tax on withdrawals discourages dipping into retirement savings. For some people, that is a feature.

Check your room before you contribute

Your available TFSA and RRSP room is shown in CRA My Account and, for RRSPs, on your notice of assessment. Contributing more than your room can lead to a tax on the excess, so confirm your numbers before you contribute. You can find the current rules on the CRA’s TFSA page and RRSP page.

The short version

Higher income now and lower expected income later points towards the RRSP. Lower income now, or money you may need soon, points towards the TFSA. Many people end up using both, and the right split changes as their income does.