Created by the federal government as registered accounts, both encourage Canadians to save. With only approximately a third of Canadians having a company pension and CPP and OAS barely covering basic expenses, the onus is on most of us to save enough to have the kind of retirement we want. RRSPs and TFSAs can help us to achieve that.

So, What Are RRSPs, and How Do They Work?

A Registered Retirement Savings Plan (RRSP) is a tax-deferred saving or investment plan. Any money you put into your RRSP is deducted from your gross income, which means you pay less tax. If your employer takes tax from your paycheque, you may get a considerable tax refund.

You can invest a maximum amount in your RRSP each year: the lower of 18% of your gross income or $31,560 in 2024. Also, any increases in the investments within your RRSP — in the form of interest, dividends and capital gains — are tax-free. However, if you don't use up all the room during working years, you can use it in future years. Your most recent tax return will show how much your unused contribution room is. 

You don't need to hold just cash in an RRSP — and it doesn't make sense to do so. You can have guaranteed investment certificates (GICs), stocks, mutual funds, exchange-traded funds (ETFs), real estate investment trusts (REITs) and bonds within an RRSP. 

You can take money from your RRSP for the Home Buyers Plan or Lifelong Learning Plan. For any other reason, you'll be charged a withholding tax immediately. It will also count as income for tax purposes. 

In the year you turn 71, you have to close your RRSP. You have a few choices on what to do with your RRSP at this point:

1. Withdraw all the cash. Remember — you will pay a hefty amount of tax on this option 
2. Transfer it into an annuity which will provide you with regular payments
3. Convert it into a registered retirement income fund (RRIF). 

RRSPs are most effective if you can get tax breaks when working in a higher tax bracket, then pay taxes in retirement when in a much lower tax bracket.

How Do TFSAs Work?

A Tax-Free Savings Account (TFSA) is similar to an RRSP because it allows your investments to grow tax-free. Contributions are not tax-deductible, but you can withdraw money anytime without paying tax. Think of both RRSPs and TFSAs as umbrellas — underneath are options like GICs, stocks, bonds, and more that you can purchase within the account. TFSAs and RRSPs are vehicles to plan your finances effectively.

The Pros and Cons of RRSPs:

The main advantages of RRSPs are:

• You get an immediate tax break when you contribute to it
• Your money grows (and compounds) tax-free
• You can carry your unused contribution room forward to subsequent years
• Your investments within RRSPs are protected from creditors

Disadvantages of RRSPs include:

• Withdrawals are counted as income and taxable
• You could be heavily penalized when drawing directly from an RRSP rather than an annuity or RRIF
• You must start withdrawing a set amount from age 71 onwards
• Withdrawals can have a negative impact on old age security (OAS) and guaranteed income supplement (GIS) benefits
• Allowable contribution limits are based on income — if you don't earn much, you can't contribute much

The Pros and Cons of TFSAs

TFSAs have several key benefits:

• Your investments grow tax-free
• You can withdraw funds at any time with no penalties or income tax
• You can recontribute any withdrawn amounts in the following year
• You can carry your unused contribution room forward to subsequent years
• Withdrawals don't have any impact on OAS or GIS

There are only two main drawbacks to TFSAs:

• Contributions are not tax-deductible
• Creditors can take investments in the case of bankruptcy

So, Which is Better for You, a TFSA or an RRSP?

For many working Canadians, contributing to both accounts would be ideal. Doing so would maximize savings, create a well-rounded investment portfolio, and provide a more comfortable retirement. However, people with low income or a low tax bracket may find a TFSA more applicable.

You certainly don't want to be in a higher tax bracket when you retire than when you were making contributions because you could end up paying more tax. If you have an exceptional company pension plan, taking out an RRSP may not make sense. And if you're over 71, a TFSA is your only option of the two.​