Most Canadians don’t know the difference between Tax-free Savings Accounts (TFSAs) and Registered Retirement Savings Plans (RRSPs). Understanding their individual advantages can save you thousands of dollars in your lifetime.
TFSAs and RRSPs – the basics
TFSA: Money grows inside this registered account tax free. It’s a flexible investment option because it’s not tied to your income and there are no tax penalties on withdrawals, providing you stay within your annual contribution limit.
RRSP: RRSP: Money contributed to your RRSP is tax deferred. Contributions to an RRSP today gives you a tax break on your current income. When you withdraw the funds, it is immediately taxed as income. If you want to avoid paying more than you saved, you can choose when to withdraw money, ideally in a lower tax bracket then when you contributed.
Who should use them?
Use a TFSA if you’re saving for a short or medium-term goal like a vacation, a house down payment, continuing education or an emergency fund. A TFSA can also be great for retirement savings if you’re currently self-employed, in a low income bracket or you want to top-up your RRSP or pension.
Use an RRSP if you’re in a middle-to-high income bracket with the intention to save long term. If you anticipate your income will be lower when you withdraw money as income, this is the best savings vehicle for you. Some families use their RRSP to cover an unpaid leave from work. There also are government programs that allow you to “borrow” from your RRSP to pay for a down payment on your first home or fund continuing education. The eligibility rules and pay back options should be carefully reviewed to a avoid a tax penalty.
Who can save in a TFSA?
TFSAs: You must be minimum 18-years-old and have a Social Insurance Number (SIN). That’s it!
RRSPs: You must be minimum 18-years-old, have an income through employment or self-employment and file regular tax returns.
How does it work?
TFSAs: Each year, the government sets an annual contribution limit for TFSAs. In 2022, the limit is $6000. You can also carry over contribution room from previous years. If you were 18-years-old in 2009 when the TFSA was first introduced and have never contributed to a TFSA, you have an accumulative allowance of $81,500 in 2022.
When you withdraw money from your TFSA, check in with your financial advisor to know when to start making contributions again, so you don’t accidentally go over your limit. Your contribution limit resets the subsequent calendar year, using the following formula:
Annual contribution limit + money withdrawn the previous year + unused contribution room to date
RRSPs: Each year, you can contribute 18% of your income up to a maximum amount identified by CRA. The contribution limit for the 2021 tax year is $27,830. You can also carry over contribution room from previous years, listed on your annual CRA tax assessment.
When you file your tax return, you do not have to pay income tax on money you’ve contributed to your RRSP. Many people get a tax return as a result.
If you’re already paying into a government pension, your contribution allowance is reduced.
The spousal RRSP
If there’s a wide income gap between you and your spouse, talk to a financial advisor about the benefits of a spousal RRSP. The higher earner can choose to put money into an RRSP for the lower-earning spouse to split income in retirement and reap the tax benefit.
TFSAs are flexible: A TFSA offers a flexible option to earn money with no tax penalty. Automate a portion of your income to save for all the things you want – flying lessons, a home down payment, a vacation or tuition. Consider a TFSA for retirement savings if you’re just starting out in your career and anticipate your employment income to grow in future.
RRSPs give you a tax break now: Routinely saving in an RRSP will give you a tax break every April. Consider putting your tax return money directly back into your RRSP to give your fund a boost. The higher your income now, the more you’ll save on income tax with your RRSP contributions.
You can also use your RRSP strategically before you retire. If you know you’ll have years of low or no income (such as parental leave), or if you want to borrow from the fund to pay for a down payment on your first home, or fund mid-career education, the RRSP can be a good option.
Many people use a combination of these funds to tap into all the advantages.
The comments contained herein are a general discussion of certain issues intended as general information only and should not be relied upon as tax or legal advice. Please obtain independent professional advice, in the context of your particular circumstances. This article was written, designed and produced by Financière SISIP Financial for the benefit of Financière SISIP Financial a trade name registered with FundEX Investments Inc., and does not necessarily reflect the opinion of FundEX. The information contained in this article comes from sources we believe reliable, but we cannot guarantee its accuracy or reliability. The opinions expressed are based on an analysis and interpretation dating from the date of publication and are subject to change without notice. Furthermore, they do not constitute an offer or solicitation to buy or sell any securities.
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Brynna Leslie, January 5, 2021