The growth in your RRSP is tax-free

The RRSP is the final boss of canadian personal finances. This page is a humble attempt at addressing the multiple misconceptions, misleading rules of thumb, and downright bad advice that are thrown all over the place.

The title above is a bit of a clickbait. The actual specific claim is this: "Gains made on your after-tax money are tax-free in both the TFSA or the RRSP". If you disagree, please read this page in its entirety because what you are thinking is likely already addressed.

Now of course, let's be clear: there is a possible difference in the after-tax returns of both accounts, but it's not due to the "RRSP gains being taxed". The only variable that impacts the difference in after-tax returns is the difference between your effective tax rate at contribution vs the effective tax rate at withdrawal.

The game behind the power of the RRSP involves finding the best optimized contribution of $X every year to maximize the spread between tax rate later and tax rate today. If you expect that spread to be negative, you obviously pick the TFSA.

Here is the classic table breaking down a $10,000 pre-tax contribution followed by a withdrawal 30 years later after growing at 7% inside either accounts:

The first and most important take-away is to notice the final amount of money in your pocket is the same in both cases, as long as the effective tax rates are equal at the start and at the end. The only thing that changes is when you paid the income tax.

The second thing to notice is you either paid $3000 today or $22,836.77 in the future. It may sting to see that amount of dollars (albeit they're inflated future dollars), but what you've been doing is effectively investing money that would have otherwise gone to the government. $3000 growing at 7% for 30 years is exactly $22,836.77.

The third thing to remember is the ability to control exactly when you withdraw from your RRSP. For example, if you do it in a year where your effective marginal tax rate is 20%, then you'll be paying $76,122.55 × 20% = $15,224.51 in income tax, bringing your after-tax return to $60,898.04. Your initial after-tax invested amount was $7000, so the annualized net rate of return over 30 years was actually 7.48%, or 15% higher than investing that same after-tax $7000 in a TFSA.

Doing that whole time every time gets clunky real fast. The following simplistic algebraic model more succinctly shows what happens in either account from the moment you receive it as gross income to the moment you have after-tax growth left in your pocket:

TFSA: Gross income × (1 - tax rate today) × Growth
RRSP: Gross income × Growth (1 - tax rate later)

Where Growth is the multiplier, in our example above it would be equal to 1.07^30 = 7.61

By commutativity of multiplication, it's easy to see you get the same after-tax returns when tax rates are equal across time. If you consider the TFSA to be "tax-free growth", you need to accept that the RRSP is also tax-free, albeit more indirectly. "TFSA is tax-free, RRSP is merely tax-deferred since you'll eventually be paying taxes on the growth" is a very misleading statement. RRSP gains are in this sense both tax-free and tax-deferred, and in many cases the addition of the income tax deferral makes the RRSP the better choice.

It is true that you will pay more nominal taxes (in inflated future dollars), because you were in a certain sense investing the government's share of the money the whole time. But if you end up with the same amount of money in your pockets after all taxes are settled, does it really matter?

Ok that's cool, but it's only really true if you always reinvest your tax refund otherwise you end up with less money down the road

That's a common misconception. When modeling the total returns of the various accounts to make your decision, any refund incurred by the RRSP contribution is completely irrelevant. Yes, it's better to invest the tax refund than blow it on dumb stuff, but that's true of any source of money. Money is fungible, cashflow is cashflow, there's nothing magical about "that" particular amount of money that came from an RRSP-induced tax refund. You can complicate the math formula from above by including taxes withheld at source followed by a tax refund that gets reinvested recursively, the end result is gonna be the same but with unnecessary extra steps that muddy the waters for no reason.

This common wisdom around reinvesting your tax refund is useful in highlighting that in order to make a valid RRSP vs TFSA comparison, you either need to gross up your after-tax contribution or gross down the pre-tax contribution depending on the exact situation you want to compare. Comparing $100 invested in a TFSA to $100 invested in an RRSP is simply an invalid comparison. That would be like comparing your net income to your neighbor's gross income and conclude he makes more than you.

Reinvesting the refund is merely one way to gross up your contribution, but it's far from the only one and you certainly don't absolutely have to reinvest your refund to avoid "missing the whole point of the RRSP". It's really all mental accounting. Adjust for pre-tax vs. after-tax and go on with day.

See /refund for a more detailed explanation if you don't believe me.

But non-registered capital gains are only taxed as 50% of income, this is better than taxing RRSP gains as 100% income

No. Non-registered capital gains are made on after-tax income. As said above, you either pay income tax today and invest what's left, or skip the income tax, invest the full gross amount and pay income tax later. With non-registered capital gains, you pay both income tax today and capital gains tax later. The non-registered account introduces a new tax that isn't present in either TFSA or RRSP.

See /capitalgains for a more detailed explanation if you don't believe me.

But I'd much rather have $500k in my TFSA than in my RRSP

Me too, buddy. That's because $500k post-tax has more value than $500k pre-tax. If a genie came out of a lamp and granted me the option of depositing a clean $500k in either account, I would indeed be a fool to pick the RRSP. But in the real world with the too-often-forgotten distinction between pre-tax and post-tax amounts, you have to remember that for the exact same after-tax cashflows invested at the same time in the same investments, you'll get to a $500k balance in the RRSP much faster than in the TFSA.

But why would I want to convert post-tax money into pre-tax money?

It is common to think about a tax-free lump sum (lottery winning, insurance payout, sale of a personal residence, etc.) and worry about "turning untaxed money into taxed money" by investing that lump sum in an RRSP. While there is some truth to it, it's not the correct framework to have.

As shown above money is only ever taxed once. What matters is looking at the tax savings incurred from your RRSP contribution today and comparing to the taxes owed later when you withdraw. Once you have computed this "sweet spot" optimal contribution amount to be $X, it doesn't matter where $X comes from, or its "untaxed" vs "taxed" status. Remember that money is fungible.

If you have $25k of taxable income and receive a tax-free lump sum of $100k, it would indeed be foolish to invest the entire $100k in the RRSP. That's because in this particular case, the sweet spot contribution amount $X is going to be much, much smaller than $100k (and very likely $0). The TFSA (or even non-registered) will be a much better place to invest this lump sum given your specific tax situation that specific year.

Tangentially related: people will often say things like "you can contribute the entire $100k to your RRSP, but delay the deductions to a later year when you make more money". This is also a misconception, ironically this misconception is the rare one that incorrectly pushes people in favor of the RRSP.

Ok, but what about OAS, GIS, CPP/QPP, DB pension, ...

That's why this whole time I've been saying "effective tax rate", which includes all income-tested tax credits and benefits. It definitely is a valid thing to consider in your personal tax planning if your expected situation in retirement includes a lot of taxable income (as their presence increases tax rate later), this might tilt the scales in favor of the TFSA. But the reverse is also important to consider, yet is never brought up when people do the blanket suggestion of "invest in your TFSA".

Furthermore, the ability to defer some of these credits while melting down your RRSP can result in way more after-tax dollars in your pockets (or your estate's pockets) beyond the simple isolated contribution model we've been using for the sake of simple illustrations.

You're overthinking this, it's actually so simple: If you make under $75k, always pick the TFSA, you should really only think about the RRSP when you make above $150k

Such rules of thumb with arbitrary income thresholds are more likely to cause people to take suboptimal decisions. Yes, if you have good reasons to believe that you will be jumping a few tax brackets in the near future, you might be better off accumulating the RRSP room and focus solely on the TFSA for the time being.

If you're only ever gonna be making $60k every year throughout your working life (following inflation) then there's a good chance the RRSP actually ends up being the better choice when it comes to long-term retirement savings. See episode #319 of the Rational Reminder podcast for much more in-depth nerdy analysis. (tl;dr average final after-tax estate value at age 95 ends up with about $1M more future dollars when the $60k-his-whole-life guy picks the RRSP over TFSA when deciding where to put his $7000/year retirement savings.)

Ok but you can easily take out money out of the TFSA at any time and you get the room back, it's way more flexible

That is true, but unrelated to the main claim of this page. The accessibility of funds is an important non-quantitative aspect in your personal decision of where you want to stash your long-term savings.

Ok but you risk getting to age 71 with a massive balance from decades of compounding such that the forced RRIF withdrawals put you in a higher tax bracket

First off, "oh no I have so much passive investment income that I have to pay so much taxes" is a very nice problem to have

Secondly, this nice problem to have can typically be avoided or mitigated relatively easily; you don't have to wait until you're legally forced to start withdrawing. Consult a professional obviously, but in many cases a large RRSP allows you to defer everything while living off RRSP withdrawals at a much lower average tax rate

And to be fair, there definitely is such a thing as having a too large RRSP balance. At some point (way before retirement) you might want to run projections around future balances and conclude that you're better off leaving the RRSP alone and focusing on TFSA and possibly even non-reg. It's highly situational, consult a professional, etc. I'm just saying that there is also such a thing as paying significantly more income taxes throughout your life when you could have deferred them and end up paying less.

"What if I end up at age 70 and look at the taxes I'm paying and regret picking the RRSP?" is common, but the inverse possibility of "What if I end up at age 70 and realize I would have an after-tax networth higher by 30-40% if I had picked the RRSP over the TFSA?" is never thought of.

Ok but if you die 1 year before retirement your entire RRSP balance is taxed as income all at once

Yes, that's a possible and tragic edge case where a tragedy happens. You can also live to 110 years old and regret having paid income taxes all those years ago during your peak earning years, rather than deferring them and investing them before ultimately smoothing their fiscal impact over many years. For every what-if that pushes you towards the TFSA there's an equivalent one that could push you towards the RRSP.

Ok but future tax rates can increase

Yes, they can also decrease. Any future government can also make some legislating changes that make it so OAS/GIS are asset-tested, or include TFSA withdrawals in the computation for how much benefits you get (while hopefully keeping TFSA withdrawals tax-free), or make countless other changes that nerf things we take for granted with the TFSA. Lots of what-ifs about what can go wrong either way. Truth is, rational tax planning takes a lot of guessworks, and many guesses can turn out to be incorrect, situations can change, we can only adapt as we go on.

Ok so how much should I invest in my RRSP then?

I don't know, that's very specific to your own situation. Analyze how much income taxes you save today, compare with your expected tax rate at retirement, run various scenarios, as long as you make an informed decision free of the countless misconceptions that I hope I have debunked on this page. Or consult a professional and make sure they don't fall for one of those misconceptions.

See what www.rrspcontribution.ca has to say about your situation, but it's only going to give you a rough idea. The real numbers will come from taking your taxes (or a close-enough draft) in february, then seeing what happens when you adjust the RRSP deduction and then make a decision from there. A common strategy is contributing enough to drop to the bottom of your tax bracket, hoping that you later withdraw below that rate – and everything else goes in TFSA or non-registered.

What about the FHSA?

Mostly including this for the sake of completeness. If you're eligible to open an FHSA, always prioritize it over the RRSP. All the stuff brought up in this page about TFSA vs RRSP becomes moot, you'll be comparing TFSA vs FHSA and going from there. At worst, the FHSA rolls over into the RRSP and you get the same tax-deferral and tax-free growth on your after-tax contributions. At best, you buy a home in time and the qualified withdrawal grants you the most powerful combination of no income tax and fully tax-free gains:

TFSA: Gross income × (1 - tax rate today) × Growth
RRSP: Gross income × Growth (1 - tax rate later)
FHSA: Gross income × Growth

You can wipe out up to $40k in taxable income by investing in an FHSA and doing a qualified withdrawal.