TFSA or RRSP? What to consider when choosing between the two

A man looks at a retirement planning brochure Monday, January 13, 2014 in Montreal. (Ryan Remiorz / THE CANADIAN PRESS)

OTTAWA -- In a perfect world, people would have enough money to top up both their RRSP and TFSA accounts. But that's probably not the case.

Investment advisers say deciding where to put savings depends on what people are saving for and where they fall within tax brackets.

Angela Dzinas, regional director for Alterna Savings in Ottawa, says investors may not know their exact marginal tax rate, but they need to understand where they are today and where they expect to be in the future.

"RRSPs tend to be beneficial in your peak earning years, especially if you believe at retirement your income will come down so that you'll be in a lower tax bracket," she said.

When people put money into an RRSP account they are able to deduct their contributions from their income, a move that allows them to defer the tax they would otherwise have to pay. The higher the tax bracket, the higher the tax refund.

But the government eventually takes its share. When retirees start withdrawing their nest egg, the money is taxed as income.

In contrast, when money is put into a TFSA, there's no deduction on an income tax return. But when the money is withdrawn, any investment gains that may have been earned are tax-free.

For someone lucky enough to hit a home run by picking a stock that soars from pennies per share to hundreds of dollars, they do not pay any tax on the gains if it is held within a TFSA.

For those in the lowest tax bracket, contributing to an RRSP may offer little advantage over a TFSA.

Chris Buttigieg, senior manager for wealth planning strategy at BMO Wealth Management, said if people are in a low tax bracket now and expect to be in a higher one in the future, they might want to favour a TFSA over an RRSP until they are in a higher tax bracket and would receive a bigger tax refund.

"I think the important thing about the TFSA or the RRSP is really the timing," he said.

In addition to the tax bracket, what investors are saving for is important.

RRSPS are designed to help save for retirement. Money can be withdrawn under certain circumstances -- to help buy a home for the first time or pay for education later in life -- but they are primarily to help in retirement.

But TFSAs can be used for just about anything and when money is withdrawn, there's no tax to pay. They can be used to save for retirement, but they can also serve as an emergency fund or a pot of money to buy a new car or take a year off work.

A recent poll done for the Royal Bank suggested that TFSAs were becoming increasingly popular among Canadians.

The online poll of 2,217 Canadians found that if they could only contribute to one option, 46 per cent picked their TFSA, while 28 per cent chose their RRSP. That compared with a result last year that found 43 per cent favoured their TFSA, while 32 per cent would go with their RRSP.

The polling industry's professional body, the Marketing Research and Intelligence Association, says online surveys cannot be assigned a margin of error because they do not randomly sample the population.

Dzinas said if people are saving for something in the short term, a TFSA can be very useful, but it can also be used to complement an RRSP.

"If you have maxed out your RRSP or you have very little contribution room to work with, then a TFSA can help boost your tax savings," she said.