RRSP Vs TFSA: Which One to Invest in First?

This would not be a Canadian personal finance blog without the analysis of which one is better to invest in first, the TFSA vs RRSP.  

RRSP vs TFSA

In this post, I will define the RRSP and the TFSA and talk about which one you should invest in first, if you had to pick one or the other and were not able to invest in both of them or max out both of them.

Answering the question, which one should you invest in first, the RRSP or the TFSA is like answering the question:

“Which one came first, the chicken or the egg?”

Well, the RRSP came first and then the TFSA, but which one you invest in first depends on a number of factors.

First, I will define what the RRSP and TFSA are.

WHAT IS AN RRSP?

The RRSP (or Registered Retirement Savings Plan) was introduced in 1957.

Yeah, that’s old, like from the Boomer era.

It is an investment account that you can contribute up to 18% of your previous year’s earned income to (to a maximum that is indexed to the annual increase in the average wage each year).

If you have a defined benefit pension, defined contribution plan, or a deferred profit sharing plan, the maximum contribution limit is decreased dramatically because of that (it is called the pension adjustment).  This is especially so with the defined benefit pensions.

The RRSP contribution deadline for the previous year is March 1 of the current year. For example, the deadline for the 2021 RRSP for tax purposes was March 1, 2022.

If you are turning 71, the last possible time you are allowed to contribute to your RRSP is December 31 of the year you turn 71.

WHAT IS THE RRSP CONTRIBUTION LIMIT?

You can find out what your RRSP contribution limit is on the CRA’s My Account.  You also can contribute for the previous year’s RRSP contribution in the first 60 days of the current year.

Here is the maximum dollar limit for the RRSP for the last five years from the Government of Canada’s website.  As you can see it has increased as it is indexed to the annual increase in the average wage.

Year	RRSP Maximum Dollar Limit
2022	$29,210
2021	$27,830
2020	$27,230
2019	$26,500
2018	$26,230
2017	$26,010
2016	$25,370
2015	$24,930
2014	$24,270

Essentially, the RRSP is a tax deferral strategy.  

You are allowed to take your money out at any time but it will be subject to tax.  

That’s why people withdraw money from their RRSP when they are retired.  There is the assumption that your income is lower during retirement years.

Related: Investing in an RRSP- Contribution Room and How to Use the RRSP

The summarize, in a nutshell, with the RRSP:

You use PRE-TAX dollars to invest in the RRSP and are TAXED when you take money out.  Money is grown tax-free within an RRSP.

WHAT IS THE TFSA?

The TFSA was brought into fruition in 2009.  It is very new compared to the RRSP.

There have been maximum contribution amounts that have varied over the years depending on which political party was running the show in Canada.  It’s now $6000 annually (as of 2019, it increased from $5500 to $6000).

You have to be older than age 18 and have a Social Insurance Number (SIN) to open up at TFSA.

Here’s the average TFSA balance by age in Canada. It’s surprisingly low.

TFSA CONTRIBUTION LIMIT

Even as a PF blogger, I find that it is hard to keep track of the total contribution amount (if you had never contributed to the TFSA before), but in 2022 it is $81,500 if you were the age of TFSA eligibility (18 years old) in 2009 when the TFSA was introduced.  

If you didn’t max out your TFSA last year, that unused contribution room from the previous year is carried forward to this year.

Here’s the current TFSA contribution and the total TFSA contribution room for your TFSA. This is assuming that you were 18 years of age in 2009.

Year	TFSA Contribution Room
2009	$5000
2010	$5000
2011	$5000
2012	$5000
2013	$5500
2014	$5500
2015	$10000
2016	$5500
2017	$5500
2018	$5500
2019	$6000
2020	$6000
2021	$6000
2022	$6000
Total	$81,500

If you have contributed to your TFSA in previous years but aren’t sure how much is allowable for this year, you can check your My CRA account to see how much contribution room you have (but it is not always accurate up to the year).

You can also call the Government of Canada Tax Information Phone Service (TIPS) to ask how much contribution room you have. It is basically the TFSA contribution room phone number. The phone number is 1-800-267-6999.

You’ll need some authentication documents on hand before you call the Tax Information Phone Service line, here’s a link to what you will need.

The last thing you want to do is over-contribute which is subject to a 1% penalty fee PER MONTH until they tell you about 7 months later that you have over-contributed (I may be exaggerating but maybe it is better now).

 Yes, I made this mistake and after a few-month ordeal, and thankfully they reversed the charges of $400+.  It was in the beginning years of the TFSA when everyone was confused about contribution room.

I over contributed and it was a bit of an ordeal to get my penalty money back.

Here’s how I fixed the TFSA over contribution.

There are also some TFSA Withdrawal Rules to be cognizant of, in order to avoid getting dinged.

Here’s how much the contribution room has varied over the years, sourced from the Government of Canada.

Anyway, the TFSA boils down to this:

You use POST-TAX dollars to invest in the TFSA and are NOT TAXED when you take money out.  Money is also grown tax-free within a TFSA.

Here are 6 ways to invest in your TFSA (and none of them are to invest your TFSA in a savings account).

Now, back to the original question at hand:  The TFSA vs RRSP:  Which one should you invest in first?

WHICH ONE SHOULD YOU INVEST IN FIRST:  THE RRSP OR THE TFSA?

This is a very difficult question to answer because it depends on a number of factors.  So the answer depends on you and your current situation and future situation and a multitude of other factors but for oversimplification sake, let’s talk about some of the factors weighing in on this decision.

Related: How Much Should I Have Saved by 40?

Here are some of the factors that can help you decide whether you should invest in the RRSP or the TFSA.

Current Income and Tax Bracket:

There is no consensus on this on the exact annual income cut off that is recommended to invest in a TFSA vs an RRSP but in general, if your income is lower (say, under $50,000 a year), you should invest in a TFSA rather than an RRSP. 

When you contribute to an RRSP you can get a tax deduction and lower your taxes payable. 

If you don’t have much tax to pay then it makes sense to save up your contribution and deduction room for when your gross income will be higher to take advantage of the tax savings.

Estimated Retirement Income

 If your retirement income is going to be high, for example, if you have a defined benefit pension (and you expect to have a high income in retirement and work your full number of years to hit your ‘magic number’), you may want to focus on the TFSA instead- because why? 

Because the RRSP is a tax deferral strategy.  However, one idea to avoid this high taxation during retirement golden years is to use the RRSP and draw it down when you are in early retirement, and before your pension kicks in.

Also, if you plan to buy back your pension after a maternity or parental leave for example, this also affects your RRSP contribution room.

How Well You can Pass the Stanford Marshmallow Test

What is your tendency towards instant gratification or impulsiveness?

 With the TFSA it is quite easy to just withdraw all your money, therefore, it can be dangerous for someone who likes instant gratification and tends to be impulsive with their money. 

With the RRSP it is more difficult because you will be penalized by being taxed. 

Case in point. I depleted my TFSA to buy a home (along with using the $25,000 RRSP at the time home buyer’s plan which was a drop in the bucket of the down payment) and it took quite a while to replenish it.  Now the Home Buyer’s Plan is $35,000.

I told myself I wouldn’t do that to my TFSA again if I can help it, because now I view my TFSA as part of my retirement savings and investment savings instead of a savings account. 

It took a while to get it back up and I don’t think I am ever going to touch it anymore. If you tend to feel #FOMO and like to have the mentality of #YOLO (like dropping $3K on a 3-day trip) then investing in the RRSP first may be better for you.

Whether You Have Children

Do you have a child?  If you have a child, the RRSP is preferred because the lower you get your net income to be (or family net income to be) the more the government will pay the Canada Child Benefit to you. 

You can check out how to maximize your Canada Child Benefit here. 

The maximum that the Canadian government will pay is around $533 a month per child under 6 but it goes down as your net income goes up and is basically completely obsolete once your family net income reaches around $200,000 (for example, in British Columbia for the 2019 tax year it was $218,500). 

The RRSP contributions and deductions can be used to reduce the net income on line 236.

Here are the Child Tax Benefit Payment Dates if you get the CCB.

What Your 1-5 Year Life Plans Are

Have you ever asked someone on a first date “What are your five year plans?  What are your one-year plans?” 

Well, I have hahaha. 

So when you think about the TFSA vs the RRSP, pretend you are going on a date with yourself and ask yourself what you plan to do with the TFSA money.  

If you want to invest to build up a portfolio so that you can withdraw it in 5 years and you are certain you will withdraw it when you have your wedding…then a TFSA would be better for you. 

In 5 years you don’t know what the market is like so you have to be prepared for selling at a loss.  If you manage to do very well with your portfolio, you can withdraw the full amount and then wait until the next year and you have that much contribution room. 

For example, let’s say you have $10,000 in part of your TFSA and the portfolio increases by 20% to $12,000.  You withdraw $12,000 for your wedding and then wait until the following year, you will have $12,000 + $6000 (or whatever the contribution room is for that year or more if you have maxed out the TFSA contribution in the past). 

With an RRSP you shouldn’t be taking out the money until retirement unless it is for the $35,000 RRSP withdrawal home buyer’s plan or the $20,000 RRSP Lifelong learning plan.

Lots of deep life questions to ask yourself, ranging from if you have kids, what your 5 year goals are, and how impulsive you are!

Try asking these RRSP vs TFSA questions on a first date and see how it goes 😉  Tell them I suggested you do it so you don’t get weird looks.

If you are still wondering how to choose between an RRSP vs TFSA, you can take this quiz from Globe and Mail here.

THE BEST SOLUTION:  WHY NOT DO BOTH?

The best solution to this RRSP vs TFSA pontification?  Just ignore the debate and invest moderately into both!

Instead of watching your RRSP and TFSA fight it out in the boxing ring for your money and attention, why not focus a bit on both?

Asset allocation is very important for your portfolio and it’s important not to have Canadian home bias because as we know the TSX has been in the pits since forever. 

Since the RRSP is a better place to stash your US dividend paying investments, use the RRSP and TFSA together and look at them instead as a whole PORTFOLIO of your retirement investments.

US equities are best in an RRSP because dividends paid within an RRSP are not subject to withholding tax (15% tax on top of the Canadian tax you pay) and within a TFSA they are.

Related:  The Ultimate Guide on Tax Efficient Investing in Canada

That being said, if you don’t care too much about the extra taxes and would rather see your money grow within a TFSA unrestricted and within one portfolio (e.g. instead of divvying things up between an RRSP and a TFSA) then you can check out this step-by-step guide on how to invest in a TFSA ETF portfolio with Questrade and all something like the VGRO ETF to your portfolio (or make that your portfolio). 

Invest in US-listed assets within your RRSP (since 2005, they removed the foreign content maximum within the RRSP so you can enjoy tax-free growth and dividends from your favourite US dividend-paying stocks without having to pay 15% withholding tax on the dividend income).

You can then take that RRSP refund you get after you do your taxes and invest it into your TFSA.

Thank you tax refund!!

Invest in fixed income (e.g. bonds) within your TFSA, invest in REITS (real estate investment trusts, more on that in my passive income post) within your TFSA, and you can also add some dividend paying Canadian companies too (or can keep them outside of the TFSA in a non-registered account).

There you have it, hopefully, this has somewhat answered the nebulous question of whether you should invest in an RRSP or a TFSA.

We now know that there is no clear answer to this question as it is dependant on a number of personal factors and you’ll need to ask yourself some deep life questions to figure out which one to invest in first if you are investing for the first time as a millennial, the TFSA vs RRSP.

Which one do you invest in first? 

The TFSA vs RRSP?