Unlocking the Power: Embracing the Benefits of Tax-Free Investing

Benefits of Tax-Free Investing

For most Canadians, investing in a Tax-Free Savings Account (TFSA) or a Registered Retirement Savings Plan (RRSP) is incredibly beneficial. 

This is because they can enjoy income through tax-free investing for the rest of their lives. Therefore, it is vital for individuals contemplating between the two plans to remember the major benefit associated with each one: tax-free growth.

What are tax-free investments?

Even though many people mistakenly believe that income earned from investments within an RRSP is taxable, this presumption overstates reality. The truth is that income tax-free investment received in an RRSP is completely tax-free. The only difference between an RRSP and a TFSA is that funds withdrawn from an RRSP are subject to taxation, but this is no different from withdrawing funds from a TFSA and paying taxes on them.

As a testament that income and tax-free growth within an RRSP (or its equivalent, the RRFI) are exempt from taxation, let’s consider a scenario as proof.

As of the start of the New Year, Dan is eligible to invest $2,000 from his post-tax income into an RRSP. However, by increasing his contribution to $3,000, he will receive a tax refund of $1,000, bringing his total savings to his current goal amount. 

Due to Dan’s marginal effective tax rate (METR) of 33.33%, this refund equals one-third of the original contribution ($3,000 times 33.33%).

When it comes to tax-free investing $3,000 into an RRSP, Dan is faced with the same dilemma as many other Canadians: where can the additional $1,000 come from? While there are a few options available to him, such as taking quick money from other non-registered funds or taking out an RRSP Loan Program at a favorable rate and paying it back when he gets his tax refund are two of the most popular.

It is generally not possible to deduct the interest on a loan; however, with the right timing, you can minimize the non-deductible amount paid. This can be achieved by taking out a loan that has a term of only two weeks and having your refund directly deposited at this point once you have filed taxes electronically. That way, you can keep the total interest paid as low as possible.

Beginning January 1st, Dan decides to invest his funds, leading to a 5% return by the end of the year. On December 31st, the RRSP increased in value from $3,000 to $3,150. Should Dan withdraw this amount before tax deductions are applied, he would be in the 33.33% tax bracket and therefore owe a total of $1,050 on his withdrawal, garnering him only $2,100 after taxes.

Considering the $2,000 investment that Dan put forth for his contribution, the $100 he earned back resulted in a tax-free rate of return of 5%. This means that not only did he defer taxes on this income, but it was also exempt from them.

At the end of December, the result of an RRSP contribution is a $100 after-tax growth. This can be determined by subtracting the net cost of $2,000 from the total amount at year’s end of $2,100. The rate of return works out to 5.

Effect of changing tax rates

Unlike other tax-free growth investments, a major incentive for investing in an RRSP is the ability to earn tax-free income from the funds put into it. Dan’s example was particularly simple, as there was no difference between his initial and ultimate METR. This means no additional effective tax rates over time benefits or disadvantages were associated with his contribution to this plan.

As demonstrated, the after-tax value of Dan’s RRSP investment taken over 40 years at 5% is compared to that which would be generated had he decided on a non-registered route. This alternate possibility involves no resulting income or gains during the accumulation phase, and upon cashing out all amounts at the end of four decades, a capital gain would be triggered with taxation fixed at a 50% rate based on Dan’s Maximum Effective Tax Rates over time (METR), presumed to be unchanging.

Comparing the RRSP and non-registered account, it is evident that the former offers a more advantageous option for Dan when his Marginal Effective Tax Rate (METR) remains unchanged. The benefits of an RRSP are even more apparent should the assumptions about the latter consider taxable income from interest or dividends earned annually and eventual gains being taxed periodically instead of at conclusion.

When evaluating the relative advantages of an RRSP over non-registered savings, one must recognize Dan’s Money Equivalency at Retirement (METR).

Considering Potential METR Increase in Retirement

Experts have raised the issue of whether building up too much money in an RRSP or its successor, an RRIFA, is a bad idea since it could lead to a high METR with withdrawals. However, depending on factors including the rate of return presumption, years available for tax-free compounding, and kinds of income tax-free investment that can be earned by saving an equal sum outside a registered account, the profits from tax-free compounding may be greater than the extra taxes from higher withdrawal METR.

Modeling a situation where Dan’s METR increases by 10% upon retirement, there would be considerable growth in savings across various accounts. After 40 years of saving, the TFSA would accumulate $14,080, the RRSP $11,969, and non-registered savings $11,463.

After 25 years, the RRSP savings begin to outpace non-registered investments. At this point, known as the “breakeven point,” neither type of investment holds an advantage. When considering different rates of return, it should be considered that the amount of time until this breakeven point decreases. Where there is a positive value, one can say that RRSPs hold more worth than non-registered investments; on the other hand, where negative values are present, then non-registered investments provide more worth.

In contrast, an exaggerated view where the non-registered account accumulates tax-free for 40 years only to be taxed as capital gains. However, a more practical situation would see the breakeven point (Figure 4) occurring much earlier due largely to taxation on the savings being taken throughout the period at a rate higher than that of capital gains.

The Role of TFSAs – Tax-free Investing

Regarding tax-free investing and retirement savings, TFSAs are an incredibly important player. The beauty of a TFSA is that all earnings from tax-free growth investments made within the account never get taxed – provided guidelines are followed. Particularly for those nearing retirement who have shorter time frames before withdrawal, TFSAs may be incredibly beneficial as their METRs (Marginal Effective Tax Rates Over Time) upon withdrawal could potentially be higher than when they made contributions.

Regarding retirement savings, TFSAs are essential for Canadians with lower salaries. Those earning a low income should endeavor to exploit their TFSA as much as possible. Any extra funds should be put into non-enrolled reserve funds instead of RRSPs because of the possible decrease in the Guaranteed Income Supplement (GIS) once they reach retirement age.

When saving for retirement, taking advantage of a non-registered account and paying full taxes on any investment income yearly can be better than using an RRSP. The reason for this is the Marginal Effective Tax Rate (METR).

Generally, TFSAs are the best route for someone expecting their post-retirement Marginal Effective Tax Rate (METR) to be bigger than before retirement – such as when they would be subjected to GIS or OAS recovery taxes. Conversely, those predicting their METR to be lower after retiring should use RRSPs. But for those not anticipating significant differences between pre and post-retirement rates, either option is suitable. If you expect your post-retirement METR to be different from your preretirement METR, then it doesn’t matter which plan you choose. 


Without a doubt, Canadians who are expecting to have the same or lower effective tax rates over time on retirement should go through RRSP investing instead of non-registered investing, regardless of their type of income and rate of return. 

However, individuals who foresee having a higher METR upon retirement may still find that tax-free accumulation achieved through an RRSP outweighs other income tax-free investment options after maximizing their Tax-Free Savings Account (TFSA). This outcome is subject to certain factors such as time horizon, rate of return assumption and investment mix (i.e. interest, dividends or capital gains).


Q. Do tax-free investments have no taxes on gains?

Tax-free investments generally do not incur taxes on gains. Any income earned within a tax-free investment, such as a TFSA, is exempt from taxation.

Q. What is the benefit of tax-free growth?

The benefit of tax-free growth is that any investment income generated within a tax-free investment account is not subject to taxes. This allows for the potential accumulation of wealth over time without the burden of tax liabilities.

Q. Is there such a thing as a tax-free investment?

Yes, tax-free investments exist. Examples include Tax-Free Savings Accounts (TFSAs), where any income earned within the account is tax-free, as well as certain government-issued bonds or other specific investment vehicles that offer tax-free status.

Q. What is the lifetime limit for TFSA in 2023?

The 2023 lifetime limit for a Tax-Free Savings Account (TFSA) is $88,000, applicable to individuals who have been at least 18 years old since 2009 and possess a valid social insurance number.

Q. What is the difference between tax-free growth and taxed growth?

Tax-free growth refers to the growth of an investment without incurring taxes on the income generated within the investment. Taxed growth, on the other hand, involves paying taxes on the investment income earned, which can reduce the overall growth potential.

Q. How do tax rates affect tax revenue?

Tax rates can directly impact tax revenue. Higher tax rates generally result in increased tax revenue, while lower tax rates can potentially lead to reduced tax revenue. It’s important to strike a balance to ensure sufficient revenue for public services while encouraging economic growth.

Q. What investments grow tax-free?

Investments within tax-advantaged accounts like TFSAs and certain retirement accounts, such as Roth IRAs in the United States, can grow tax-free. Additionally, certain government-approved bonds and other specific investment products may offer tax-free growth options.