There is plenty of debate about whether RRSPs or TFSAs are the best place to park your savings, but financial advisers say if you understand the advantages and disadvantages of each, there is little reason not to use both.

"Both the RRSP [registered retirement savings plan] and the tax-free savings account form a very important role in an overall financial plan," explains Jared Webb, an adviser with Fernhill Financial in Victoria, B.C.

"They're both very effective.They're both fantastic tools. One is not better than the other, really. They serve different purposes. Like any tool in a tool chest, if you use the proper tool for the job, it's the most effective."

It's the tax treatment that's different, and that can make a difference when deciding which one is right for you.

"Tax-free savings accounts and RRSPs are simply just tax strategies," Webb said. "They're just telling the government how to treat, from a tax perspective, your holding or your investment."

In the case of RRSPs, the taxes on any contributions you make are deferred until you withdraw the money — hopefully, in your retirement, when you're making less income and are in a lower tax bracket.

For TFSAs, the contributions you make have already been taxed, but you aren't taxed at all on interest or other earnings within the account. Nor are you, in most cases, taxed when you withdraw the money — although there are some exceptions.

U.S. citizens also have to be careful about using TFSAs, which are more heavily taxed in Uncle Sam's hands. Under the new rules requiring Canadian banks to report the holdings of U.S. citizens, the U.S. Internal Revenue Service is scrutinizing all the holdings of U.S. citizens living in Canada.

'A huge impact'

RRSPs, which have been around for longer and have more contribution room, hold far more of Canadians' money at the moment — just over $1 trillion in RRSPs compared to $157.9 billion in TFSAs.

There are about 14.3 million TFSA accounts with an average balance of $10,996, according to Investor Economics. Statistics Canada's latest numbers for RRSPs shows just under six million Canadians made contributions in 2013, though the numbers don't say how many people have RRSPs but didn't make a contribution that tax year. The median contribution was $3,000.

In either case, these two savings vehicles can be key tools for helping you reach your savings goals.

"The biggest expense anyone faces in Canada is taxes," Webb said. "That's the largest expense by far that we all face. So, if we can reduce or defer those taxes for as long as possible, then it has a huge impact on someone's overall financial plan and your ability to achieve what you're trying to achieve."

Webb said, ideally, people would take advantage of both plans, but he knows that's not necessarily realistic.

So. which is right for you?

Reasons to save in an RRSP:

  • You want a steady stream of income from your savings in retirement: An RRSP gives you the chance to save more (18 per cent of your income to a maximum of $25,370 in 2016). This can build, with savvy investment, into a nest egg for when you stop working. "It is basically a self-funded pension plan. That's the whole intent of it," Webb said.
  • You want to reduce your taxable income: Any contribution to your RRSP comes directly off your taxable income, with the potential to push you into a lower tax bracket. "If you put $5,000 into a registered retirement savings plan, they would tax you as if you had made $5,000 less that particular year," explained Michael Hlinka, a CBC business columnist and an instructor at George Brown College in Toronto. "Any gains [that] would occur have no tax implications until you withdrew the money."
  • You need to put your money somewhere you won't get at it easily: It's painful to withdraw from an RRSP. There is a withholding tax that can be as high as 30 per cent if you withdraw money before retirement, which should discourage you from using your RRSP funds for a vacation or other purchase you could easily postpone.

Reasons to save in a TFSA:

  • You are young and your income is low: If you are in a low tax bracket, you get less benefit from the tax-saving aspect of an RRSP contribution. But if you save the RRSP contribution room until your 30s or 40s, when you are earning more, the tax reduction will pay off. Webb said TFSAs are a good place to put money away during your time as a student or early years of working.
  • An RRSP isn't an option: There are two ways that can happen. Either you've reached your contribution limit on your RRSP or you've turned 71 and are no longer allowed to contribute to an RRSP.
  • You have enough coming to you later in life that you're worried about clawbacks to Old Age Security: RRSP withdrawals are considered income, so that combined with, say, a strong pension could result in a clawback on your OAS if your income exceeds a set limit ($72,809 in 2015.)

Hlinka and Webb both said that all things being equal, the RRSP is the preferred choice for long-term savings, but that it always depends on the saver's personal situation. Hlinka said anybody wanting to map out their retirement should get a financial planner.

"What I feel comfortable doing ... is to offer some generic information," he said. "But I would not go on a talk show and talk to someone for 30 seconds and make that determination that one's better than the other."

RRSPs vs. TFSAs
Features RRSPs TFSAs
Contributions

Your personal contribution limit is based on income, pension adjustments and how much you contributed to RRSPs in previous years — up to a maximum contribution limit that changes each year ($24,930 in 2015, $25,370 in 2016).

You have to stop contributing on Dec. 31 of the year you turn 71.

Up to $5,500 in 2016, plus any unused portion from previous years since 2009 (if you were at least 18 during those years). The limit for anyone opening an account today would be $46,500.
Withdrawals

You can withdraw from your RRSP at any time but will be taxed on the amount you take out.

Most people wait until retirement to take advantage of a lower tax bracket.

If you make a withdrawal from an RRSP, you lose that contribution room forever.

There are some withdrawals that an be made without suffering a tax penalty — namely, those made under the Home Buyers' Plan and the Lifelong Learning Plan, but both are subject to repayment conditions.

Funds can be withdrawn at any time. (It's tax-free, because the savings you put in were after-tax anyway.) The amount you withdraw in one year can be put back in a future year, over and above your contribution limit for that year. If you have met your contribution limit, you cannot take funds out and replace them in the same calendar year.

Penalties

Any withdrawal from an RRSP prior to your retirement year is subject to a withholding tax at the time of withdrawal of five to 30 per cent (five to 15 per cent in Quebec) depending on the amount withdrawn (with the exception of those made under the Home Buyers' Plan and the Lifelong Learning Plan).

The withdrawn amount is added to your income, and you may end up having to pay more tax on it when you do your return for the year.

From age 19, the CRA allows up to $2,000 in excess contributions beyond your annual limit; beyond that, you may have to pay a penalty of one per cent per month.

If you contribute more than the limit for a given year, you incur a penalty of one per cent for each month you are over the limit.

Tax-deduction limits

The maximum amount of RRSPs you can deduct from your taxes in a given year is equal to your contribution limit.

You can choose to deduct less and use the unused portion to increase your contribution room the following year beyond the annual maximum.

Money deposited in TFSAs is not tax deductible and neither is the interest on money borrowed to invest in TFSAs.

Tax benefits

Earnings in RRSPs are not taxed until they are withdrawn.

Any of the growth in your TFSA — including interest, investment income, dividends and capital gains — is not subject to tax, even if withdrawn.

Investment possibilities

High-interest savings account, mutual funds, guaranteed investment certificates, listed securities and other types of qualified investment products.

High-interest savings account, mutual funds, guaranteed investment certificates, listed securities and other types of qualified investment products.