TFSA vs. RRSP — Here's How They Affect Your Taxes In Canada

It can be tempting to put off thinking about your retirement, especially if you're still in school or just starting your career. But the fact is, the earlier you start investing in your retirement, the longer your money has to grow. In theory, the best time to start investing is, well, yesterday.

In Canada, anyone aged 18 and up with a social insurance number can start investing in their retirement. Understanding a bit about how it works and how it can affect your taxes – whether you plan to file your taxes yourself or not – can be useful.

When it comes to retirement investments, there are two main programs people talk about: the Registered Retirement Savings Plan (RRSP) and the Tax-Free Savings Account (TFSA). Each one has its pros and cons. Let's break down what RRSPs and TFSAs can and can't do.

What's the point of an RRSP and TFSA?

Both RRSPs and TFSAs are called savings vehicles. This means that this money doesn't have to sit around gathering dust and earning little to no interest. The money in your savings vehicles can be put in investments — anything from a low-risk, low-reward Guaranteed Investment Certificate (GIC) all the way to high-risk, (potentially) high-reward stocks. What you choose to invest in will depend on your comfort with risk. (Younger investors, for example, might feel like they have more time to recover in the case of sustaining a loss on their investments; older investors might not want to take that risk.)

Keep in mind that investments will grow much more over time than a simple savings account will, but that money is supposed to stay in your savings vehicles for long periods of time. Conventional wisdom advises against leaving all your money in an everyday savings account, where the interest rate will be less than the rate of inflation over time, but to still make sure to keep some money is in a regular savings account in case of an emergency.

What's the difference between an RRSP and TFSA?

The main difference between RRSPs and TFSAs is if and when you get taxed on the money you invest and the interest you earn. (Don't worry, it'll make sense in a minute.)

When you invest in an RRSP, you're investing pre-taxed money. This means that you can deduct the amount you invest in your RRSP from your income for the year on your taxes — so if you earn $50,000 and put in $5,000, you only need to pay tax on $45,000.

But taxes are inevitable. All the money you eventually take out of your RRSP when you're retired gets taxed when you take it out. The idea here is that when you retire, you'll probably be in a lower tax bracket, so you'll pay less tax on that money in retirement than you would at the height of your career.

TFSAs are kind of the opposite. The money you put in a TFSA has already been taxed — so if you earn $50,000 and put $5,000 in your TFSA, you're still paying taxes on the full $50,000. But any interest your investments earn over the years in your TFSA is tax-free.

While there are maximums on how much you can invest in RRSPs and TFSAs, there is no minimum. And the longer an investment is in a savings vehicle, the more time it has to grow.

This article’s cover image was used for illustrative purposes only.