The RRSP seems like this complex investment vehicle with all these rules and restrictions but with a couple caviets it offers essentially the same tax free growth that a TFSA does albeit with a couple gotchas. If you need the basics first, start with What is an RRSP?.

How the TFSA and RRSP work.

Before I can explain how a RRSP is basically a TFSA we need to look at how a TFSA and RRSP work.

Taylor the Tax Free Saver

Taylor makes $60,000 a year and sets aside $6,000 for retirement, they like the idea of investing their money “tax free” so they decide to put that money into their TFSA and passively invest it making 7% annually it would grow to $11,800 in 10 years. If they used a TFSA they could withdraw the full amount tax free.

Riley the Retirement Saver

Riley also makes $60,000 a year and sets aside $6,000 for retirement, they like the idea of investing their money and getting a tax refund to increase their retirement contribution! They deposit $6,000 into their RRSP and get a $2,528 refund that that they can add to their initial deposit for a total of $8,528. Passively invested it will grow at 7% annually and will be $16,777, if Riley is still making $60,000 and wants to withdraw the full amount from their RRSP they will have $11,653 after income tax.

Taylor and Riley have basically the same outcome

As you can see in the above example Taylor and Riley used totally different strategies but the result was nearly the same, assuming your marginal rate is the same at deposit and withdraw the effect of an RRSP is identical to a TFSA

Reinvesting your refund

You might believe that comparing Riley and Taylor is an unfair comparison cause Riley invested $2,528 more then Taylor but that money didn’t come from Riley, it was actually from the government as a result of commiting initial $6,000 of post-tax income to their RRSP. I explain that partnership framing in Your RRSP Refund Isn’t Free Money. See the RRSP vs TFSA vs Unregistered calculator for a side-by-side comparison showing how the government buys a stake in your RRSP, and why the refund isn’t free money.

Another way to think of what Riley has done is they lent themselves $2,528 in February that they will contribute to their RRSP (in addition to the $6,000) and they will get that back when they claim the tax deduction in April.

In fact if you fill out a T1213 you can have the income tax your employer deducts from your income reduced by $2,528 ahead of time to provide you the liquidity to make the larger RRSP contribution.

Get your tax refund early

RRSP and TFSA contribution room

Each year Riley and Taylor will get $6,000 in TFSA room and 18% of their reported income as RRSP room, in their case that will be $10,800 ($60,000 x 0.18). To compare these numbers fairly we need to reduce our RRSP room by our marginal rate (this is to compare after tax dollars), in Ontario both people have a marginal rate of 29.65% meaning that the after tax RRSP room is $7,597 which is significantly higher then the amount of TFSA room gathered per year.

We can even simplify this and take the 18% x (100-29.65%) = 12.66%, that means that for a person who makes $60,000 they get 12.66% of their reported income as tax free growth in their RRSP.

We can also run the numbers for “Bob the big spender” making $120,000 at a marginal rate of 43.41% would be 10.19%. When we compare this to Riley and Taylor 10.19% is less then 12.66% but as a portion of their reported income Riley and Taylor only get $7,596 and Bob has $12,228 of tax free growth in their RRSP.

When the TFSA comes out ahead

When you make a withdrawl from your TFSA you can contribute that amount again in January, when you withdrawl from an RRSP you don’t get that room back. This means that if you think you will need this money sooner rather than later you should probably use the TFSA so that you get that room back the following year

When the RRSP comes out ahead

The RRSP results in the same withdraw amounts as the TFSA when your marginal rate is the same at deposit and withdraw. If the median retirement income of an individual is $27,000 that means as long as your contributing to your RRSP at an income of more then $54,000 you will more then likely withdraw at a lower tax bracket then you deposited at which increases your effective return by the spread on your marginal rate from deposit to withdraw.

Caveats and Considerations

If you’re still not convinced you can read this paper looking at the RRSP in great detail. If you are convinced I should note that there are some situations that may make you hold off contributing to one account over the other.

1. You are making less then $30,000: Median income in retirement is $27,000 so if you make around that amount you should prioritize your TFSA and even unregistered investing over your RRSP. See TFSA or RRSP or Unregistered for the full priority list.
2. You are buying a home or going back to school: The Home Buyers’ Plan lets you borrow up to $60,000 from your RRSP for a down payment, repaid over 15 years. The Lifelong Learning Plan works similarly for full-time education: up to $20,000 ($10,000 per year), repaid over 10 years starting the second year after you leave school.
3. You are moving to the US: Canada and the United States have a tax treaty that recognizes the RRSP as a retirement account but not the TFSA. If you plan a temporary move south and won’t need the money, rolling TFSA funds into an RRSP can avoid taxable events.

Active trading rules are looser in an RRSP than a TFSA, but an unregistered account is usually the better place to trade frequently. US dividend stocks also belong in the RRSP: foreign withholding tax does not apply there.

If you want to open a TFSA or RRSP checkout this guide here

Next Steps

1. The paper by Chris Reed is 30 pages but definitely worth a read as it covers several topics and misconceptions with the RRSP not covered here
2. There is a brief article here by Frances Woolley which goes over what is decribed above with a few different examples
3. There are several other strategies that can be used in combination with your RRSP to reduce your tax obligation like the RRSP meltdown which increase the spread on your marginal rate at time of withdraw, or deferring your deduction to a higher-income year when that bet makes sense