I get asked this question all the time – “What’s the difference between a TFSA and an RRSP?
– Difference: taxation on the way into and out of these accounts
– Tax Deferred growth in both accounts
– These are accounts, not investments
Both these accounts are very similar except for how they are taxed. On an RRSP, you get a ‘tax break,’ meaning, if you put money into an RRSP, it will be deducted from your income and you will receive the taxes you have already paid back after you do your tax return.
Example. You earn $50,000 and contribute $5000 to your RRSP. Your income comes down to $45,000 but you have paid tax on $50,000. The tax paid on that $5,000 gets refunded to you.
The RRSP is therefore an ‘un-taxed’ pool of money. If you take money out, you will then need to pay tax.
TFSAs are different in that you do not get a tax break on the way in – in our example, your $5000 does not reduce your income. Which means your account is a ‘taxed’ pool of money and is not taxable when you withdraw it.
They both benefit from tax deferred growth – meaning you don’t pay taxes on the interest, dividends or capital gains from the investment in these accounts. But how they are taxed on the way in and on the way out is the difference.
And you’ll notice I never said anything about these being investments – that is because neither an RRSP nor a TFSA is an investment – they are accounts. If you choose to put GICs, Mutual Funds, Stocks or Bonds in these accounts is up to you. But they are just that – accounts.
Which one should you do? I can only make a recommendation if I know your specific circumstances but one thing is certain – you should do one of them!