What Is The Difference Between a TFSA and an RRSP?
Both the TFSA and RRSP have an impact on your wealth building potential
When it comes to the Registered Retirement Savings Plan (RRSP) and the Tax Free Savings Account (TFSA), we know the acronyms. In fact, we hear the acronyms, too. On the radio, on the news and from our friends. But, also, we are seriously befuddled with how the CRA thinks we know what these acronyms actually mean.
Really, Canada? Can we please diverge a little bit more information on whether or not these accounts are for us, specifically?
As someone who isn’t an expert, a financial planner or a financial advisor — I feel you. It’s frustrating to attempt to learn this information on your own. However, I also know the desire to ensure that your financial future has some kind of road map. I love money and I never want to have to worry about money.
Let’s look at what the TFSA and RRSP are, what they can do for you, compare and contrast the two accounts based on research, and go over how I manage my accounts personally.
What is a TFSA?
A TFSA or Tax-Free Savings Account is for Canadians 18-years and up. So, rather than going to the bar to celebrate, you can go to the bank and open this very versatile account — which is exactly what you want to do, right?
The TFSA is a place for you to save money in a tax-sheltered account. Amounts contributed to the account and income you earn from the places you invest within the account are also generally tax-free. I say “generally” because if you use it as an investment tool your returns are tax-free, BUT (because there is always a but), if you go over the contribution limit, have non-qualified or prohibited investments within the account, or are a non-resident during a time that you are contributing, you’ll be taxed. So, just make sure you do your research, follow the rules and you will be fine.
It’s also free to withdraw from this account — which is super nice. Although they call the account a savings account, it’s most valuable as an investment tool. Just putting your money into a TFSA doesn’t do much for you. You need to invest that money into stocks, mutual funds, GICs, bonds and ETFs so that your money can grow tax-free.
This account was introduced in 2009 and initially had a limit of $5000. In 2013, they got crazy and increased the limit to $5,500 annually, and then in 2014 they went wild and were like NOW IT’S $10,000. Reverting back in 2015 to $5,500, taking us to the present day, in the year 2019, where the annual contribution limit is $6,000.
Any unused room can be carried forward — Therefore, if you have never opened a TFSA before, you can contribute up to $63,500 in 2019.
With a TFSA, you can withdraw money from this account any time you want, without having to pay tax on the withdrawal. Once you withdraw, you never lose that contribution room. Instead, you can contribute that money back into the account in the following year. So, if you take out $40,000 in 2019, you’ll have $40,000 + $6,000 of contribution room in 2020 or indefinitely. Just make sure to check if your financial institution has a hold on the funds when you do go to withdraw, in case you need that money to close on a house and they’re like Oops, sorry, we need 48 hours to disperse the funds.
Contributions you make to your TFSA are not tax deductible — which means that they don’t reduce your taxable income or tax liability. That’s where the lovely and much older RRSP comes to play.
What is an RRSP?
An RRSP or Registered Retirement Savings Plan is a tool that the Canadian government created to help people save for retirement. Like the TFSA, money within your RRSP is invested into a diverse lot of assets — mutual funds, stocks, etc. — and while they sit inside this account, you will not be taxed on any capital gains or dividends that you earn. This account is tax-deductible and can reduce the taxes you owe come that time of year.
The first R in RRSP is registered, and registered accounts have a few more rules than some. Rules include who can set up an RRSP, how much contribution room you have each year, what kind of investments you can use within the account, how to withdraw money and when these accounts must be closed or converted into RRIFs (Registered Retirement Income Funds). God, don’t you just love all the acronyms.
As soon as you have an employment income and file your taxes, you can open an RRSP. Contribution limits are unique to you. You can take into account whatever the deduction limit is this year and any unused contribution room from past years. If you’re wondering where to find your contribution limit, check out the Notice of Assessment that you got after filing your taxes last year. The 2019 RRSP contribution limit is 18% of earned income you reported on your tax return in 2018, up to a maximum of $26,500.
Are you confused? You really shouldn’t be. Just check out your own contribution limit and that’s all you need to know right now.
Withdrawal from an RRSP isn’t quite as simple as a TFSA. With an RRSP, there are again — rules. Who doesn’t like following the law?
Though, it’s also important to note that there are ways to withdraw before this time. Typically, there are only a few reasons a person would ever need to withdraw money from their RRSP before they retire: job loss, buying a home, education. If you withdraw simply because you “need the money”, There are consequences called withholding tax, in which the financial institution will hold back 10-30% of the withdrawal and give it to the government. You may also be dinged come income tax season, as the money is withdrawn is considered taxable income.
If you want to take the money out tax-free for the RRSP Home Buyers’ Plan or the Lifelong Learning Plan you can also take these options. Please note that these two options do not fall under the remainder of today’s explainer.
Otherwise, if you’re doing withdrawal the good old-fashioned way which is when you are old & wrinkly and finally retiring — you can withdraw the money. There are two types of tax you will need to know about in this situation: withholding tax and your marginal tax rate.
Withholding tax: a tax that’s withheld when you make a withdrawal from your RRSP. The money withheld by your financial institution is passed to the CRA. The rate of tax varies depending on the amount you withdraw and the province you live in.
In every province except for Quebec, these are the tax rates:
|$0 - $5,000||10%|
|$5,001 - $15,000||20%|
In Quebec, these are the tax rates:
|$0 - $5,000||5%|
|$5,001 - $15,000||10%|
*Note that in Quebec, you also pay a provincial sales tax of 16% on top of the withholding tax.
Marginal tax rate: This tax rate is the combined federal and provincial taxes you will pay at income tax time. Your financial institution will give you a T4-RRSP which shows the amount you withdrew and taxes withheld. You will have to declare this amount.
You can begin to withdraw in retirement at age 55, by converting your RRSP into an RRIF and receive payments. Once you make this decision, you can not flip back. Ensure that once you’ve made this choice, you will have enough money to take you to the end of your — life. Ugh so dark, my bad.
If you choose to wait to withdraw, you have until December 31 of the calendar year you turn 71 years young. At that point, the RRSP will turn to an RRIF. Note that once you withdraw money from this account, you do not get that contribution room back.
TFSA or RRSP?
Both the TFSA and RRSP have a great impact on your potential wealth building opportunities. Generally, financial experts will tell you that the RRSP is great for long-term goals like retirement, and TFSA’s are great for short-term goals — like a vacation or a down payment fund. The important thing to remember here is that most financial experts will tell you that “short-term investments” are five years minimum. Investing for less time than this isn’t going to show you the return you probably hope for. So, for example, if you are saving for a down payment, yes, your TFSA could be a great option if you are saving for five or more years. However, the TFSA can and should be used for long-term savings as well.
The times an RRSP might be best are as follows:
You earn a high income (>$50,000) and have contribution room available
You're investing for the future and earn a high income (>$90,000)
Your work has a company matching program that can and should be maximized
The times a TFSA might be best are as follows:
You are investing for retirement and earn less than $50,000/year
You expect your income to increase significantly in the future, leaving more contribution room in your RRSP and a higher tax deduction
You should be using both! And be investing in both! The TFSA is good for anyone of any income level, and the RRSP is great if you achieve a higher income or you have maxed out your TFSA.
One way you can use both the RRSP and TFSA together?!
If you find that an RRSP if best for you, maximize your RRSP contributions to earn a tax refund. Once you receive that tax refund, put that refund directly into your TFSA. This gives you a diverse and flexible way to use both accounts.
How do I use my RRSP and TFSA?
My RRSP — this was the first investment account I opened and I didn’t do so until I started a good career in 2015. At this time, my company had a great matching program, so I have my account stored in Manulife and with a diverse portfolio of investments. I contribute to this account monthly.
My TFSA — I opened this account in 2016 and was at the time, using it as a savings account. When I realized I could be doing more, I opened a TFSA with Wealthsimple and started investing. I contribute to this account monthly.
I know a ton of you are going to ask “when should I use which account and why and how” and I get it! It’s overwhelming. But hopefully, this answered a few of your questions. For more specific questions you should contact a financial planner or professional that can advise you on what’s best for your personal financial goals. I hope to be that for you one day, but for now, I’m simply just like you — a person who deeply cares about her money and wants to make the best of every tool available.