Thanks for the question. It has been asked for years. I’ll answer by comparing a standard situation and determine which is better. But, before that, it is important to note that TFSA contributions have greater contribution limitations than RRSP contributions. If a TFSA is up to date, the contribution limit is only $5,500 per year. If you have more to save the choice is between the RRSP or the non-registered account. There is no debate the RRSP is the better option than the non-registered account for savings earmarked for retirement.
Here is the scenario I’ll work through. Two people earn $100,000 and both save $5,000 per year and earn 6% per year on their savings. Mr. RRSP contributes into an RRSP. The contribution generates $2,171 of tax reduction. Mr. RRSP takes the $2,171 and invests it into a TFSA. We need to do this for an “apples to apples” comparison. Mr. TFSA invests the $5,000 into a TFSA. They both continue this for 20 years. After year 20 Mr. RRSP has $194,964 in the RRSP and $84,653 in the TFSA. Mr. TFSA has $194,964 in the TFSA. (Yes, Mr. RRSP's RRSP and Mr. TFSA's TFSA grow to the same amount.)
They both retire. Both have $35,000 of income in retirement from other sources and both want to add to this. Both pay $4,758 in tax on the $35,000. Mr. RRSP redeems $15,000 from the RRSP / RRIF and pays an additional $3,553 in tax due to the RRSP / RRIF withdrawal. He then redeems $3,553 from the TFSA. Mr. TFSA redeems $15,000 from the TFSA with no tax consequences. Both now have after-tax income of $45,242. This happens every year in retirement. Let’s look at account progressions. At the end of the 20th year of retirement, Mr. RRSP has $40,384 in the RRSP and $132,953 in the TFSA. Mr. TFSA has $40,384 in the TFSA. Clearly, Mr. RRSP is in the better financial situation.
The spreadsheet shows all the numbers. Note the spreadsheet has two tabs. Tab 1 is the contribution years. Tab 2 is the withdrawal or retirement years.
The above is number-centric but simply consider this. They earned and saved the same amount while working, they earned the same rate of return, they had the same after-tax income in retirement, but by the 20th year of retirement Mr. RRSP has more money.
Both the RRSP and TFSA provide tax free compounding. The scenario illustrates the power of the first incentive of the RRSP: the reduction in taxable income and therefore income tax with RRSP contributions.
Mr. RRSP paid less tax per year in the working years than Mr. TFSA and invested the tax savings in the TFSA. In retirement Mr. RRSP pays more tax per year than Mr. TFSA but is still wealthier both before and after-tax.
Here is a scenario where both earn $60,000 and both have close to $31,000 of after-tax income in retirement. The conclusion is the same.
I'm loving the RRSP in both scenarios.