For certain goals, choosing the right account type is easy. For example, if you want to save for your child’s or grandchild’s post-secondary education, RESP without a doubt is the most suitable account type. But it’s not always as easy to pick between a TFSA, RRSP, or an individual (taxable) account.
TFSAs are extremely flexible and allow you to save for any goal. TFSAs allow you to invest your money tax free, but unlike RRSPs the contributions don’t provide a tax deduction. The amount you can contribute is set every year by the Canadian government and also depends on what year you turned 18.
Any amounts withdrawn from a TFSA can be re-contributed in the following calendar year. Since the TFSA is a tax-free account there is no tax to be paid when you make a withdrawal. Any income, dividends or capital gains realized within a TFSA are also tax-free.
RRSPs were primarily designed to help Canadians save and invest for their retirement. Any amount that you contribute to an RRSP reduces your taxable income for the year it is deducted, often resulting in an income tax refund at tax time.
RRSPs are less flexible than TFSAs. Any amount you withdraw from an RRSP cannot be re-contributed except in certain circumstances (Home Buyers' Plan and Lifelong Learning Plan). Since you do not pay income tax on the contributions to an RRSP, when you make a withdrawal the amount withdrawn is added to your taxable income that year. Early withdrawals from an RRSP are also subject to withholding tax.
RRSPs are most beneficial for those who are in the highest tax brackets. For most people that make less than $50,000 per year, a TFSA is actually a better way to save for retirement than an RRSP.
To get the most out of an RRSP, you want to contribute to it during your highest income years and withdraw when your income is lower.
A taxable account, is just a regular investment or savings account that has no special tax advantages like a TFSA or RRSP. You pay income tax on interest and dividends when they are received and any capital gains are taxed when you sell an investment.
For most people, taxable accounts should be contributed to last.
I Still Don’t Know Which to Choose
Ask yourself this question: What am I saving for?
If the answer is not “retirement”, then choose a TFSA. Once your TFSA contribution room is used up, then choose a taxable account.
If you answered retirement, then look at your annual income.
If you make less than $45,000 per year, you would want to contribute first to a TFSA, then to an RRSP and finally to a taxable account.