Hello;
Have you ever faced a decision of trying to choose between an RRSP (Registered Retirement Savings Plan) and TFSA (Tax Free Savings Account)? This is a question I get asked often. Hopefully, this blog will give you the insights to help you decide.
A Little Background on RRSPs
An RRSP account is essentially a tax deferral mechanism. You put money into an RRSP and defer paying the tax until it is taken out as income sometime in the future, perhaps at retirement. When you invest in an RRSP you get a tax deduction which could result in a refund of tax you paid during the year. When you withdraw money from an RRSP, your withdrawal counts as income for that year and you are taxed on that money. The ideal scenario is to contribute to an RRSP during your high earning years to maximize the tax refund, and make your withdrawals in low income years such as during retirement when you are in a lower tax bracket. The added bonus with RRSPs is that the growth in the account is tax-sheltered until withdrawn. This feature allows your money to grow faster because you don’t have to pay tax on investment income annually like you do with non-registered accounts.The amount you can invest is a function of your income; 18% of the previous year’s income to be exact up to a yearly maximum ($27,830 for 2021). Unused contribution room is carried forward indefinitely and can be used in future years when you have extra cash to invest from say a bonus or severance package. If you have not maximized your contribution, a running total can be found on your notice of assessment from the CRA.
RRSPs are designed to provide you with income once you decide to stop working. With the cost of living increasing over time, the importance of personal savings like an RRSP to supplement workplace and government pensions is essential now more than ever.
A Little Background on TFSAs
The TFSA was created in 2009 and the contribution amount is the same for everyone, currently its $6000/year. The total allowable contribution amount for 2021 is $75,500. If you have more than one TFSA or have taken money out in previous years, you can find out your contribution limit online through your Service Canada account. TFSA’s are almost the exact opposite of RRSP’s. Before we talk about the differences, let's review the similarities. Like an RRSP, a TFSA is also a registered account and therefore lets you grow your money tax sheltered; thereby paying no tax on investment growth in the account. However, unlike an RRSP, you will not receive a tax deduction or refund when you invest in a TFSA. But, on the flip side, withdrawals from a TFSA are tax-free. TFSA’s are much more flexible, meaning you can take out money for anything. Whereas, with RRSPs you can only take out money penalty-free if you're buying your first home or under the Lifelong Learning Plan. Also, TFSAs do not expire whereas RRSPs must be converted to a Registered Retirement Income Fund (RRIF) by Dec 31 of the year you turn 71. Furthermore, unlike the RRSP, you do not lose your contribution room if you redeem money, the only catch is you must wait until the following year to re-contribute otherwise it may be counted as a double contribution and result in a penalty.
So Which Do You Choose?
In most cases, if you are earning over $45,000 in income, need some tax relief and do not need the money for a specific purpose, I would suggest investing your extra cash into an RRSP. If you are saving for something specific like a car or vacation; the TFSA would be a better option. Ideally, you should spread out your savings and contribute to both. Whether you choose the RRSP or TFSA (or both), the important thing is to start saving now and make regular contributions to both accounts. That way, you know you have all your bases covered.
If you are still having trouble trying to decide, or have any questions, give us a call.
Mani Fenili (20-May-2021)
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