When to use RRSPs, TFSAs and RESPs

Many Canadians may be familiar with the various investment accounts they can use, but how many really know the difference between a registered retirement savings plan (RRSP), a tax-free savings account (TFSA) and a registered education savings plan (RESP)?

While you can add stocks, bonds, mutual funds and ETFs, among other investments, into all of them, your approach may be different for each one. Here’s how to use these accounts properly.

RRSPs for retirement

What is an RRSP?

The RRSP is still the most popular investment account in Canada. You can add more into it than other registered investment accounts and money inside of it grows on a tax-deferred basis – although many people think it grows tax free. While you can get a tax refund when you make an RRSP contribution – your deposit lowers your taxable income, which can potentially push you into a lower tax bracket, hence the return of some of your already paid taxes – you will still have to pay the Canada Revenue Agency (CRA) on any contributions and investment gains when you withdraw in retirement.

How should you use an RRSP

For the RRSP to work to your advantage, it’s best to invest when you’re in a higher income bracket and then withdraw when you’re in a lower one. Of course, it’s hard to predict your financial situation later in life. If you save diligently and still have other sources of income coming in your golden years, your withdrawals could end up pushing you into a higher tax bracket. It’s a good idea to talk to a professional before removing money from an RRSP.

Which investments should you consider?

As for what to put into an RRSP, most experts suggest having a diversified mix of stocks and bonds. Generally, you’ll want your portfolio to be tilted more toward equities when you’re young, as you’ll have more time to recover if the market falls. As you get closer to retirement, you may want to lean more toward bonds. While fixed income investments don’t rise nearly as much as stocks, they also don’t fall as hard in tough times and you’ll want to make sure your money is protected the closer you get to withdrawing it.

TFSAs for short-term and long-term saving

What is a TFSA?

Thanks to its name, TFSAs are often misunderstood – it’s far more than just a savings account. A TFSA is an investment account where money grows tax free. You contribute after-tax dollars, which means you won’t have to pay anything to the CRA – not on capital gains, dividends or bond income – when you withdraw. TFSA rules are such that you can only contribute $6,000 per year from 2019 to 2022, $6,500 for 2023 and $7,000 for 2024, which is less than what you may be allowed to put into an RRSP, but the total amount one can contribute to a TFSA has grown significantly over the years. If you were at least 18 years old and a Canadian citizen when the TFSA was introduced in 2009 and you haven’t put any money inside of one yet, then you’ll have $95,000 in total contribution room in 2024. That makes it great for short- and long-term savings alike.

What’s the best way to use a TFSA?

If you’re in a high-income tax bracket (more than $216,511 in 2021), use the TFSA after you’ve already maxed out your RRSP, as the benefits of using an RRSP still outweigh the benefits of a TFSA for people in this group. If you’re a lower earner, though (making, say, $30,000 per year) a TFSA is ideal since the tax benefits that make the RRSP attractive won’t apply. Anyone, though, will benefit from using a TFSA thanks to that tax-free investment growth.

Which investments should you consider?

Many people may want to have the same asset mix in their TFSAs as do in their RRSPs, but it’s possible to do something different as well. You’ll want to look at your entire portfolio, including pensions, RRSPs, real estate and other assets, to see how conservative or aggressive your entire asset mix may be. If you find that your other assets are protected from a downturn, then you may be able to take on a little more risk in a TFSA, since you won’t be taxed on any capital gains. Of course, asset mix depends on time horizons and risk tolerance levels, but you may want to consider weighting this account more toward equities.

RESPs for education

What is an RESP?

An RESP is similar to an RRSP in that it’s an investment account where money grows on a tax-deferred basis. There are two main differences to the RESP rules, though: savings can only be used for education-related expenses and it’s possible to get government grants – essentially free money – deposited into your account depending on how much you contribute.

What’s the best way to use an RESP?

If you can, open one up when your child is born and start contributing right away. Generally, if you contribute $2,500 a year you’re eligible for $500 in annual government grants (up to a lifetime maximum of $7,200 in grants per child), so it’s recommended to try and save at least that much. Family members can also open up an RESP or contribute to an existing one, but you can’t put more than $50,000 into the account over its lifetime.

Which investments should you consider?

It’s all about the time horizon. If you’re starting out when your child is young, then you may want to hold more equities than fixed income, as you’ll have time to recover if the market goes awry. As your child gets closer to university age – usually 18, but you can continue contributing until your child is 31 years old and the plan can remain open for 35 years – you may want to move those funds into more conservative stocks and bonds so that you don’t lose too much in a potential downturn. It’s a similar investment approach to an RRSP but done over 18 to 30 or so years rather than 40.

While RRSPs, TFSAs and RESPs are great for savings, each one operates differently and therefore requires at least a slightly tailored investment approach. How you choose to invest will depend on your personal situation and what other assets you have; but use each one in a way that helps you best achieve your financial goals.