Your TFSA and RRSP are two essential investment accounts that you can access. Both are fantastic tools for growing your wealth.

Which one you should choose? The answer is, it depends.

First, make sure you fully understand the difference between the TFSA or RRSP.

Here are five simple steps you can take to maximize your after-tax TFSA and RRSP.

1.    TFSA vs RRSP after-tax formulas

Remember these simple formulas:

  1. If you will have a lower income tax rate in retirement than when you’re working = More after-tax income from your RRSP than your TFSA
  2. If you will have a higher income tax rate in retirement than when you’re working = Less after-tax income from your RRSP than your TFSA.
  3. If you will have the same income tax rate in retirement and when you’re working = Same after-tax income from your RRSP and your TFSA.

Most people are in a lower tax bracket in retirement than in the later years that they are working.

Here are three tables that show how this works:

Retirement tax rate less than working tax rate

 TFSARRSP
Investment$10,000 $10,000
Tax Rate (Working)30%30%
After-tax Investment$7,000 $10,000
Age2525
Number of Years Invested4040
Rate of Return7%7%
Investment at age 65$104,821 $149,745
Tax Rate (Retirement)0%20%
After-tax investment at retirement$104,821 $119,796

Retirement tax rate greater than working tax rate

 TFSARRSP
Investment$10,000 $10,000
Tax Rate (Working)30%30%
After-tax Investment$7,000 $10,000
Age2525
Number of Years Invested4040
Rate of Return7%7%
Investment at age 65$104,821 $149,745
Tax Rate (Retirement)0%40%
After-tax investment at retirement$104,821 $89,847

Retirement tax rate equal to working tax rate

 TFSARRSP
Investment$10,000 $10,000
Tax Rate (Working)30%30%
After-tax Investment$7,000 $10,000
Age2525
Number of Years Invested4040
Rate of Return7%7%
Investment at age 65$104,821 $149,745
Tax Rate (Retirement)0%30%
After-tax investment at retirement$104,821 $104,821

2.    Understand your marginal tax rates

To correctly answer the TFSA vs RRSP “which is better” question, it’s essential to know what your current income and marginal tax rate are currently.

The reason it’s so important to understand your tax rate is because your RRSP provides a deduction equal to your marginal tax rate.

Because of this, it stands to reason that the higher your marginal tax rate (the more money you’re earning), the more taxes you will save by contributing to your RRSP.

To give you an idea of how much you can save in taxes in your RRSP, in British Columbia in 2019, the combined federal and provincial marginal tax rate for incomes between $40,708 and $47,630 is a reasonable 22.80%.

By the time you reach an income of between $95,259 and $113,506, your tax rate will be a hefty 38.29%. That is a high amount, and almost double the taxes you could be saving if you invest in your RRSP at a higher income.

If your income tax rate will be less than the 38.29% in retirement, you will be netting more after-tax money by contributing to your RRSP than your TFSA.

3.    TFSA or RRSP: Start with your TFSA

When you’re young and starting out your career, chances are your income won’t be in the higher tax brackets yet. Because of this, I recommend maxing your contribution room to your TFSA before your RRSP.

The 2020 TFSA limit is $6,000, and if you were over the age of 18 when the TFSA started in 2009, your total contribution room would be $69,500 as of 2020.

Here are a few reasons to start with your TFSA before your RRSP:

  • More flexible
  • Transparent and easy to understand
  • Doesn’t lock your money in without paying taxes to take it out
  • Your tax rate starting out will be lower than when you’re older

4.    RRSP or TFSA: Older and higher tax bracket, use the RRSP

If you’re nearing retirement and in a higher tax bracket, with an income closer to $100,000, you can start making RRSP contributions. Your tax rate, depending on the province you live in, will be between 35-46% tax at this point.

If your income in retirement will be lower in retirement than during your working years like most people, then this will net you more after-tax dollars.

5.    One crafty strategy to maximize your TFSA vs RRSP

If you’re getting into the higher tax brackets and you’re ok with locking in your money until retirement, you can try this strategy.

If you’re quite sure that your retirement income tax rate will be higher than your working income tax rate, you can take out some money from your TFSA and contribute it to your RRSP.

If you’ve built up a large RRSP contribution room, this can be a great strategy that could net you more retirement money.

Conclusion

The most important thing to remember is to keep contributing consistently and often to both your TFSA and RRSP. By carefully managing which one will give you the most benefit, you can maximize your after-tax return in retirement.