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, arbitrary misleading rules of thumb, and downright bad advice that are thrown all over the place.

Specifically, the central claim of this whole page is "Gains made on your after-tax money are effectively 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 mathematical version is very easy to grasp in my opinion, with a somewhat simplistic model of after-tax returns to get the idea outlined explicitly:

By commutativity of multiplication, it's pretty easy to see you get the same after-tax returns when tax rates are equal across time. Meaning if you consider the TFSA to be tax-free, 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 to make in light of all this.

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. But if you end up with the same amount of money in your pockets after all taxes are settled, who cares? It's a win win.

Plus, don't forget you have way more control over the "tax rate later" variable when planning your retirement income and spending, compared to the "tax rate today" which in many case is simply whichever tax bracket your salary puts you in (plus CCB, CGEB, etc. wherever applicable)

The game of RRSP becomes 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.

Ok that's all fine and good, but it's only really true if you 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, 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.

This common wisdom around reinvesting your tax refund serves to highlight 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. 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 "otherwise you're missing the whole point of the RRSP". It's really all mental accounting as I'll demonstrate:

Imagine a scenario where you have a 40% marginal tax rate, $10k available in chequing that you would like to invest in your RRSP, and you also have a $3000 bill coming up. What's the best move?

In scenario 1, you end up with an RRSP balance of $9,800. In scenario 2, you end up with an RRSP balance of $11,000. In both cases the $3000 bill has been paid and there's $0 left in chequing. How is this possible? Simple: you invested more after-tax money in scenario 2 than in scenario 1. Of course if you invest more you get a bigger balance!

Even better yet, consider scenario 3 with the same variables:

Suddenly you now have $11,666.66 in your RRSP at the same point in time as in #1 and #2, the bill has also been paid and you also have $0 left in chequing. How is that possible? Simple: you invested more after-tax money than in other scenarios. Of course if you invest more you get a bigger balance! The deception actually lies in the fact that the reinvested refund in #1 and #2 takes place in a different tax year, so you'll get a refund on that contribution in another full year. By grossing-up explicitly with a loan like that, you get the immediate result of reinvesting your refund recursively for infinitely many years (or until you get to less than a penny refunded or run out of RRSP room).

Granted, not everybody has access to cheap credit or a well-funded up emergency fund to temporarily dip into in order to do this magic gross-up trick. The goal of this demonstration is to explicitly bring attention that everything that goes inside the RRSP immediately becomes pre-tax, and will become post-tax once you withdraw. There is no such thing as getting "taxed twice on the same money" if you misuse the refund.

Refund or not, it's really all accounting details that get settled at tax time, mixed with a large dose of mental math. What truly matters is the after-tax portion of your contribution. $10k invested that gets you $4k back means you invested $10k for the actual after-tax cost of $6k. The remaining $4k inside the RRSP actually belonged to the government, and the income tax deferral comes in the form of a matching $4k refund outside the RRSP. If you insist, you can view the refund as the $10k getting "untaxed". It will get retaxed later when you withdraw from the RRSP, for a total number of exactly one total time getting taxed.

Of course if you blow that $4k on cocaine and hookers the minute you get it, you'll end up worse off down the line than if you had invested $10k in your TFSA. But that's not due to some intrinsic property of the RRSP, it's just that $10k is more than $6k!

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. You are strictly introducing a second form of taxation that reduces your after-tax returns.

So basically if your tax rate later is close to 0%, the non-reg will essentially approximate the behavior of a TFSA. But if tax rate later = 0%, you would have still been better off investing the entire gross amount all those years ago. On the flip side, if tax rate today = 0% then yes, don't contribute in the RRSP just yet.

(And yes, for the sake of simplicity I'm ignoring the yearly tax drag from dividends and interest earned in the non-registered account, they only serve to make the non-reg look worse than RRSP)

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 jumps out of a lamp and grants me the option of $500k in either account, I'd be a fool to pick the RRSP. But in the real world with the too-often-forgottent distinction between pre-tax and post-tax balances, you have to remember that for the exact same 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 it's "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. (And no, contributing to RRSP and delaying the deduction to a later year is not necessarily a good move)

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 is a valid thing to consider in your personal tax planning if your expected situation in retirement includes a lot of taxable income, 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

You're overthinking this, it's much simpler: 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 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 from the TFSA at any time, you get the room back, it's way more flexible

That is true, but unrelated to the main claim. 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.