How to Choose the Best Canadian Investment Account Type

Learn whether a TFSA, RRSP, FHSA, or RESP is the best tax-sheltered investment account for your financial needs.

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You have several choices for tax-sheltered investment accounts, each with advantages and disadvantages. A common mistake is taking the names of these accounts literally without considering the full potential and uses of each. Their names are suggestive but not restrictive—these tax-sheltered accounts may be more flexible than you realize.

Taxes On Unsheltered Investments

Before comparing the different types of tax-sheltered accounts, it’s helpful to understand how unsheltered investments are taxed. Sometimes, it’s appropriate and advantageous to invest outside a tax-sheltered account. Minimizing the taxes due on your investments is one of the most important aspects of growing and preserving your wealth.

When you own an investment (e.g. stocks, bonds, real estate besides your primary residence, precious metals, collectibles, crypto, etc.) outside of a tax-sheltered account, you will owe taxes in two scenarios:

Capital Gains

When you sell an investment, if you receive more money than you paid for it, that difference is taxable. A capital loss is the opposite—when you lose money on an investment. On your tax return, these gains and losses will offset.

Capital gains are taxed at 50% of your marginal (top) tax rate. For example, if you’re in the 40% income tax bracket, you’ll owe tax equal to 20% of your gain.

Capital gains are only generated when you sell an investment (except for some mutual funds that pass along small internal capital gains annually). This ability to control when taxes are due is beneficial because you can compound your investment returns for decades without paying taxes on those gains. The potential downside is if you sell an asset that has grown significantly (>$50K) in a single tax year (e.g. maybe you want to switch investments), it can push you into a higher tax bracket, generating more tax owing than if you had sold incrementally over time.

Distributions

Some investments will pay you to hold them. For example, some stocks will pay ongoing dividends, and bonds will have scheduled interest payments. Cash in a savings account can also pay you interest. You will be taxed on these distributions in the year you earn them.

Interest is taxed at your marginal (top) tax rate (i.e. the same as employment income), making interest-generating investments the least desirable to hold outside of a tax-sheltered account.

Conversely, dividends are taxed much less than capital gains or interest—unfortunately, the calculation is non-trivial (see simple tax calculator). Suffice it to say that dividends are (usually) hugely tax-advantaged compared to the other types of gains (especially if your employment income is less than $50K), which is why dividends are the preferred method for covering ongoing living expenses by the F.I.R.E. (Financial Independence Retire Early) crowd. If you need to hold an investment outside a tax-sheltered account, dividend-paying stocks are usually the most tax-efficient.

Holding your investments in a tax-sheltered account allows you to avoid taxes on both forms of gains. Therefore, as a general rule, you’ll always be better off using a tax-sheltered account than not (assuming the asset is eligible—non-traditional assets like crypto and collectibles are not). However, choosing the best tax-sheltered account depends on your specific financial situation.

TFSA (Tax-Free Savings Accounts)

If you’re unsure what kind of investment account to start with, use a TFSA. They are far and away the most flexible and most practical. Unfortunately, their name doesn’t do them justice—don’t confuse a TFSA with a traditional bank savings account. It also doesn’t help that some financial institutions have versions of TFSAs designed and marketed as simple replacements for cash savings accounts. Holding cash for any length of time is problematic (due to inflation), and reducing the taxes owing on the small amount of interest you’ll earn on that money will have minimal impact on your financial situation. Tax-sheltering cash is a very ineffective way to use a TFSA (and tax-sheltered accounts in general).

Taxes

TFSAs have almost the same flexibility as an unsheltered investment account (e.g. the ability to access your money quickly and a wide variety of investment choices), with the added benefit that your gains are not taxed (regardless of their source). For example, if you contribute $5K to your TFSA and it grows to $10K, you can withdraw the entire $10K with no tax consequences.

Since TFSA accounts do not affect your taxes in any way (you invest after-tax dollars), you do not report your contributions or withdrawals on your tax return.

Here is a simple example of the benefit of investing in a TFSA versus an unsheltered account:

Growth of $10K over 10 years, with an annualized 5% return and 2% dividend, assuming employment income of $80K

Contributions

Each year, you accumulate a fixed dollar amount of contribution room (see limit history), which carries forward year-to-year whether or not you have a TFSA account. As of 2024, the annual contribution limit is $7K, and the cumulative lifetime limit is $95K.

Withdrawals

There are no limitations on when you can withdraw money from your TFSA. The most valuable feature of a TFSA (unique to TFSAs) is that you regain contribution room equal to your withdrawals the following calendar year. For example, if you withdraw $10K today, you will have $10K of additional contribution room next year (plus your annual new allocation). It doesn’t matter if the initial contribution that generated the $10K withdrawal was only $5K (or $20K).

Eligibility

You start accumulating contribution room at age 18 (if you turned 18 after 2009 when TFSAs were introduced) and continue accumulating space until death. Note that some provinces require you to be 19 (age of majority) to open an account. You don’t need to be a Canadian citizen, but you do need to be a resident of Canada (by tax standards) to accumulate contribution room (snowbirds take note).

Estate Planning

As with all financial accounts, you can name a specific beneficiary for your TFSA account. A spouse has special privileges when you name them as successor holder (or they fill out some paperwork within 30 days of your death). This privilege allows them to inherit not just your investments tax-free but also keep the TFSA account, which means the investments can continue to grow tax-free until they withdraw them (or their death). But note that your spouse will not inherit any available contribution room you’ve earned but not used.

If you name anyone else as beneficiary, they will inherit the value of the assets tax-free as cash but won’t get to keep the TFSA account (and therefore the contribution room).

Bottom Line

TFSAs are the most general-purpose tax-sheltered investment account. They remain useful throughout your lifetime because you can repurpose them for different goals in each stage of life. TFSAs are suitable for any medium to long-term investing during your earning years (e.g. house downpayment, kids’ college fund, retirement, house renovations). For seniors, if you’ve got extra money to invest (e.g. from a pension or forced withdrawals from your RRIF), a TFSA is the ideal place to save it because it can grow tax-free, and there will be no taxes due upon death (unlike a RRIF).

TFSAs make practical emergency funds unlike other tax-sheltered account types because your contribution room returns after withdrawals.

It’s a common misconception that TFSAs are more restricted in their asset choices than RRSPs—the available investment choices are actually the same. If your account has limitations, it’s because your financial institution has placed arbitrary restrictions on the specific version of the TFSA account you’ve opened, not a general restriction of TFSAs. If you are stuck with limitations, you can transfer money or assets from one TFSA account (or financial institution) to another without withdrawing it.

RRSP (Registered Retirement Savings Plans) / RRIF (Registered Retirement Income Fund)

An RRSP has a few critical differences compared to a TFSA, but they complement each other exceptionally well, so there’s no reason why you can’t and shouldn’t maximize using both.

Taxes

The most significant difference between an RRSP and a TFSA is that you get to defer taxes on your RRSP contributions until you withdraw them (hopefully at some distant point in the future)—meaning you get to invest pretax income in your RRSP rather than after-tax income, as you would in your TFSA.

For example, if your income is $80K this year and you make RRSP contributions totalling $10K, you’ll be taxed as if your income were $70K. This tax treatment has multiple benefits:

• Since you will owe less income tax, you can contribute more to your RRSP and still have the same take-home pay versus a TFSA. For example, with $80K employment income, you could make a $10K TFSA contribution or a $13.1K RRSP contribution.
• When you invest the taxes you save now, you grow and compound them tax-free for decades. This additional invested money wouldn’t matter if the tax rates were symmetric (the same now as later), but they’re not.
• When you contribute to your RRSP, you save taxes at your marginal (top) tax rate today. When you withdraw from your RRSP, you pay taxes at your average tax rate later. So even if we assume your pre- and post-retirement income will be the same (usually, it’s lower in retirement), you’ll often pay half as much tax.

Because of these tax benefits, RRSPs are more valuable to higher-income earners than lower-income earners. The breakeven point at which an RRSP is obviously better than a TFSA is taxable income of more than $50K–$60K per year.

The main downside of RRSPs is that your gains, when withdrawn, will be fully taxed as if they were income—you’re losing the tax advantages that capital gains or dividends would otherwise have in an unsheltered account. Even so, the benefits of an RRSP still vastly outweigh the drawbacks compared to an unsheltered account for most people.

Here is a simple example comparing how long money from an RRSP, a TFSA, and an unsheltered account will last, assuming no other retirement income (or CPP):

• Save for 35 years
• $80K employment income and retirement income ($64.5K after taxes)
• Contribute $5K after-tax income per year (which means the RRSP contribution will be $6.4K)
• Assume a 5% annualized return plus a 2% dividend which gets reinvested

Comparison of saving for retirement in a TFSA versus RRSP versus unsheltered account

The RRSP comes out meaningfully ahead with an income of $80K. The RRSP will be much further ahead if your income is higher. The TFSA will be better if your income is below $50K–$60K.

Contributions

Unlike a TFSA (where everyone receives the same contribution room), you earn new RRSP contribution room each year equal to 18% of last year’s employment income (to a maximum of $31.5K as of 2024). Your current contribution room is reported on your income tax assessment each year. Contribution room carries forward every year, regardless of whether you have an RRSP account.

Two essential details are: (1) you only earn contribution room from employment income (e.g. not from investment income), which means lower income or young people won’t have much contribution room, and (2) contribution room can only be used once (unlike a TFSA).

You can contribute to your RRSP at any time, with contributions counting towards the current tax year (with a grace period of 60 days extending into next year). You can continue contributing to your RRSP until you convert it into an RRIF (Registered Retirement Income Fund), which you must do by age 71.

Withdrawals

You can withdraw money from your RRSP without penalty (including before retirement), but you will incur the previously deferred taxes (i.e. it will count as income in the current tax year). Your bank must withhold a fixed percentage as prepaid taxes, depending on the withdrawal size. The main downside of early withdrawals is you can’t recontribute that money later except in two specific scenarios:

• You and your spouse can each withdraw up to $60K tax-free from your RRSPs to buy a house if you qualify as a “first-time” home buyer (i.e. you did not own a home in the last five years). You have up to 15 years to recontribute that money without penalty.
• You can also withdraw up to $20K tax-free ($10K per year) to return to school.

Once you convert your RRSP to an RRIF during retirement, you must withdraw a minimum percentage of its value each year (which increases as you age).

Eligibility

You start accumulating contribution room as soon as you begin earning employment income, and there is no minimum age to open an RRSP (unlike a TFSA). But a teenager would likely be better served saving that RRSP contribution room until their higher earning years (unless they’re currently earning more than $50K) and invest using a TFSA instead (if they’re old enough).

Estate Planning

You can name a spouse or financially dependent child/grandchild as the RRSP account beneficiary. In this case, the account and investments will be transferred and remain sheltered and untaxed until the beneficiary sells the assets and withdraws the money.

For any other beneficiary, the entire value of the account becomes taxable income on your final taxes. If your RRSP/RRIF is large (>$100K), this could represent a huge tax bill (>50%). Thus, drawing down your RRIF in retirement before withdrawing from other investments (certainly before your TFSA) makes sense. A common tactic is to defer taking CPP as late as possible (age 70) and withdraw more from your RRIF initially to make up the difference. For example, if your annual CPP benefit at age 65 would be $10K, you could withdraw an additional $10K from your RRIF each year from age 65–70 and start drawing CPP at age 70. Your take-home pay should be unaffected (only a financial advisor can tell you definitely) because the 42% increase in annual CPP benefits will usually compensate for your smaller future RRIF withdrawals. The advantage of this strategy is that you reduce the size of your RRIF, thus reducing the risk of dying with a huge tax liability.

Another helper tactic for reducing your potential RRIF tax bill at death is, if you have TFSA contribution room, you can withdraw more than you need to live from your RRIF each year, pay a little more tax now and let the money grow tax-free in your TFSA instead. From a tax perspective, when both spouses die, ideally, neither would have money in their RRSPs/RRIFs, and all investments would be in TFSAs because then there will be no tax bill that reduces the size of your legacy. For anyone under the age of 50 now, you should have ample TFSA contribution room during retirement to slowly move all your money from your RRIF to TFSA, unless you’re very wealthy (in which case you’ve probably already hired expensive experts to minimize your tax-owing).

Bottom Line

RRSPs are optimal for retirement savings because they let you defer taxes from your higher tax (earning) years to your lower income years (retirement), but they’re not limited to that use. For example, you could withdraw from your RRSP when taking a few years off work (e.g. taking a sabbatical or raising children). The point is that money withdrawn from your RRSP will get taxed, so it’s best tax-wise to withdraw it during your lowest income years, whenever they happen to be. Usually, this will be during retirement, but not always. If you wait until death, the tax bill could be up to 50% (for large RRSPs).

RESP (Registered Education Savings Plans)

RESPs are intended to help you save for your children’s post-secondary education. But they can also be used for any family member (e.g. stepchild, grandchild, nephew, niece, sibling). Their main attraction is that the government will match some of your contribution, which is essentially free money. This benefit offsets their lack of flexibility.

Taxes

Like a TFSA, an RESP uses after-tax dollars as contributions. But, unlike a TFSA, there are tax implications for withdrawals, which are different if the original contributor withdraws the money or the beneficiary (child) withdraws it.

Contributions

There is no maximum contribution limit per year—instead, there is a $50K lifetime contribution limit per child. The government will match up to 20% (or up to 24% if you’re lower income) of your contribution each year (maximum grant of $500–$600), with the ability to carry over unused contribution matching for up to one year. This matching is called the Canadian Education Savings Grant (CESG). Additional grants are also available from various levels of government for lower-income families.

The lifetime CESG grant limit is $7.2K per child (e.g. when you contribute at least $36K). Since the grants are capped per calendar year, you’d need to spread your contributions over 15 years to maximize them.

Withdrawals

The original contributor or the beneficiary (child) can withdraw money from an RESP. Beneficiaries can only withdraw money once enrolled in a qualifying post-secondary education program.

How the money is taxed depends on who withdraws the money and from which pool the money is withdrawn: (1) original contributions (principal), (2) the government grants, or (3) investment gains on the principal or grants:

• When the beneficiary (child) or contributor withdraws from the principal, it is not taxed (it was previously taxed in the hands of the contributor).
• When the beneficiary withdraws investment gains or government grants, it is treated as taxable income. However, since most students will have little income, they will likely pay little to no taxes on that money.
• When the contributor withdraws investment gains, it gets taxed as regular income with an additional 20% penalty. So, tax-wise, it makes sense for the beneficiary to withdraw investment gains and grants first (rather than principal). If money remains at the end, the contributor can withdraw the principal tax-free, not the gains. Another note is the contributor can avoid the 20% penalty if they contribute the gains to their RRSP (assuming they have contribution room). The contributor cannot withdraw the government grants—instead, they must repay them.

Money must be withdrawn from an RESP within 36 years.

Eligibility

RESPs must have a named family member as beneficiary (or several in the case of a family plan) because the money is intended for them.

Estate Planning

RESP can have multiple subscribers (contributors), unlike other tax-sheltered accounts. These contributors could be a spouse, grandparent, or other family member. When there are several subscribers, no action is required upon the death of one of the subscribers. However, when an account with one remaining subscriber dies, the RESP will be closed and become part of their estate. It does not pass to the beneficiary—which is different from the other account types where the beneficiary inherits the assets in the account.

Bottom Line

The best part of an RESP is the government’s 20% (and potentially more) matching—it’s free money. If your children don’t attend post-secondary education, you can always use that money to make an RRSP contribution (to avoid the 20% penalty). But if you do reclaim your contributions, you will pay taxes on the gains (as income), which is actually worse than if the investments were in an unsheltered account (because capital gains and dividends would have been tax-advantaged) and definitely worse than a TFSA with no taxes.

That said, the government grants alone don’t make an RESP a slam-dunk. For example, if you have TFSA contribution room available, you could save in your TFSA instead, forgoing the government grants for substantially more flexibility and fewer potential tax headaches.

FHSA (First Home Savings Accounts)

FHSAs were created in 2023 in response to the (government-created) affordability crisis in housing. Despite the hype associated with their introduction, I’m not sure how much benefit most Canadians will reap. Most people don’t need more tax-sheltered ways to save money—90% don’t maximize their existing tax-sheltered savings options. And I suspect the vast majority of the 10% who have maximized their contribution room aren’t eligible for a FHSA because they’re higher income, older Canadians who already own a home. Instead, most people need less expensive houses, which this new account type does nothing to help. Nonetheless, FHSAs have some intriguing aspects that could be useful to some people, even though many of their benefits overlap with TFSAs and RRSPs.

Taxes

FHSA contributions reduce your taxable income, meaning you contribute pretax money, the same as RRSPs. Thus, FHSAs benefit higher-income individuals more than lower-income individuals, the same as RRSPs.

Contributions

Like a TFSA, you have a fixed contribution limit of $8K per calendar year and can carry over up to $8K of unused contribution room per year. You have a lifetime maximum contribution limit of $40K.

You only accumulate contribution room once you open an account (unlike RRSPs and TFSAs). You can contribute to your FHSA for up to 15 years and must close it by age 71.

Withdrawals

You can withdraw money from your FHSA anytime, but it will be taxed as regular income unless you use it to buy a house. Like an RRSP, you do not regain contribution room from withdrawals.

Unlike an RRSP (which has a tax-free withdrawal limit of $60K under the Home Buyers’ Plan), you can withdraw the total value of your FHSA tax-free for buying a house. You can also combine your RRSP withdrawals with your FHSA to buy your home.

The most significant limitation of FHSAs is that when you withdraw money to buy a house, you must close the account within a year. You must withdraw any remaining money as cash or transfer it to your RRSP/RRIF.

Eligibility

The name first-time is a little misleading. To qualify for an account, you cannot have owned a house this year or in the past four calendar years.

You must be at least 18 (or the age of majority in your province) and under 71 to open an account, and you must be a Canadian resident (by tax standards).

You and your spouse can each open FHSA accounts, but you each need to qualify individually (in terms of no recent home ownership).

Estate Planning

Upon death, your spouse can inherit your FHSA account tax-free (if they are named successor holders), same as an RRSP, but they must qualify as a first-time home buyer or move the money to their RRSP/RRIF. Otherwise, the account’s value will become taxable income for the named beneficiary (which is strangely different than an RRSP) or taxable income for your estate if there is no beneficiary (like an RRSP).

Bottom Line

When saving to buy a house, FHSAs and RRSPs are similar, but there are two key differences:

• FHSA contributions and gains will never be taxed as income (when used towards home ownership), whereas RRSPs are only tax-deferred (and must be repaid)
• You can withdraw $60K from your RRSP versus your entire FHSA (regardless of size).

These advantages make FHSAs clearly superior in saving money to buy a house.

But even if you don’t intend to buy a house or use the entire value of your FHSA towards your downpayment, there’s another reason for everyone (who is eligible) to prefer maxing out an FHSA before contributing to an RRSP—you can transfer investments from an FHSA to your RRSP tax-free without consuming your RRSP contribution room. This feature makes an FHSA like an extra $8K in contribution room for your RRSP each year. Since you can’t carry over the FHSA contribution room indefinitely (like you can with your RRSP), there’s no reason not to use it before contributing to your RRSP. There’s zero downside and all upside.

Another benefit is that an FHSA provides tax-sheltered contribution room when your RRSP contribution room is limited. For example, if you have a pension that reduces your available RRSP room or have yet to earn much RRSP contribution room due to lower employment income or limited time working.

Unfortunately, FHSAs will likely be of limited benefit to most people. For example, anyone who will never max out their RRSP or TFSA contribution room will see no advantage over using those instead.

Emergency Funds

Everyone should have an emergency fund with 3–6 months of living expenses, but it’s essential to differentiate between true emergencies and unscheduled expenses.

Emergencies should be low-probability and high-consequence events (e.g. job loss, severe health events, natural disasters).

Unscheduled expenses are the ongoing costs of upkeep for the things you own (e.g. car, house, cottage) or unplanned living expenses (e.g. kid’s braces). These expenses are relatively predictable, even if their timing is unplanned—there will always be something that breaks, even if you’re not sure what it will be. Too many people don’t appreciate and consider the actual cost of ownership of their choices and only look at the initial purchase cost. For example, the actual cost of a car is often double the purchase price, a pet can cost a few thousand dollars annually, and you might be less inclined (unfortunately) to have children if you knew their expected lifetime cost (hundreds of thousands of dollars). You must be ready for these standard ongoing costs and have cash available rather than scrambling when they arise. And if you’re lucky and nothing expensive happens, contribute that extra cash towards accelerating your mortgage payments, saving for retirement, or going on vacation.

Since true emergencies should be rare, I prefer to pair my emergency fund with a secured line of credit. That way, I can safely invest my money in higher-growth assets, knowing that I can draw upon my line of credit rather than being forced to sell my investments during market downturns. As a result, I don’t need to keep my emergency fund in cash or mediocre, lower-returning safe investments (which lose purchasing power over time to inflation). The point of an emergency fund is to have the financial flexibility to deal with unexpected situations, not necessarily to have cash on hand. If you are debt-free (other than your mortgage), it is much easier to use your available credit when an emergency arises.

TFSAs make good accounts for emergency funds since withdrawing the money will have no tax consequences, and you can recontribute it later.

Summary

In an ideal world, you would use all of your available tax-sheltered contribution room and wouldn’t have to decide which account type to use—you’d use them all. It’s no coincidence that the annual 18% RRSP contribution limit is close to the recommended savings rate of 20%. If you max out your contribution room across each account type and pay down your debts, you should have very healthy retirement savings, especially if you start early and invest for growth (as you should).

But since maxing out contribution room is out of reach for most people, here are some simple heuristics for your long-term savings (e.g. retirement):

• If your income is <$50K, use a TFSA first, then FHSA (if eligible), then RRSP once you exhaust your contribution room from the others.
• If your income is >$50K, use an FHSA first (if eligible), then RRSP, then TFSA.

For medium-term savings, a TFSA is the perfect choice. A RESP can also make sense to save for post-secondary education if your kids are likely to pursue that option and you want to help them financially.

TFSAs are ideal for investing extra cash during retirement so you can draw down your RRSP/RRIF.

Key Points

• TFSAs allow you to invest after-tax dollars for medium to long-term goals in every era of your life—they are the most versatile investment accounts.
• RRSPs/FHSAs allow you to defer taxes from your higher-income to your lower-income years (or eliminate taxes if buying a house with an FHSA), which is ideal for saving for retirement or buying a home.
• RESPs allow you to invest after-tax dollars for your children’s education, with the government matching 20% (or more) of your contributions.

Points to Ponder

• Are you using your accounts to their full potential? Have you only used them strictly based on their name (RRSP for retirement, TFSA for saving cash)? The goal is to have the accounts you need, not to check a box that you have one of each type.
• Are you investing in assets that grow or just saving cash? Due to inflation, cash loses purchasing power every year, so you want to minimize how much you hold. Hoarding cash is the opposite of prudent saving—it will guarantee you’re getting poorer every year.
• Do you have an appropriate plan for emergency situations? Why not? What would happen if you had to come up with $5K next week?

Related Concepts

• Why Passively Managed, Low-Fee Index Funds Are Ideal Assets
• Why Dollar-Cost Averaging Outperforms Lump-Sum Investing
• Why Compound Interest Is the Secret to Growing Your Savings

If you have comments, questions, or constructive feedback, you can contact us by email at questions@essentialsofinvesting.com.