RRSP and TFSA – which one is better for ME?

photo credit: Sebastiaan ter BurgWhen pondering old questions such as “TO DO” or “NOT TO DO” when deciding between the two investment tools RRSP and TFSA, it is worth taking time to understand the plans fully and correctly.

What is an RRSP?

RRSP stands for Registered Retirement Savings Plan and is a federal government sponsored program which allows Canadian residents who have earned income during the current calendar year to save up to 18% of that income and invest it, with the purpose of growth. The RRSP money is primarily invested with the purpose of generating income during the retirement years, to complement social benefits. Investments can be equities, bonds, GICs, mutual funds or ETFs. The amount of money invested in your RRSP will be deducted from the taxable earned income, thus creating a tax savings (which in reality is a tax deferring mechanism). Normally, during retirement, the tax rates for Canadian residents are lower than during their active working years, and therefore the deferring of tax may create real tax savings (sometimes, but not always). Unless you have significant experience with investing, it is advisable to consult a professional.

How much money can I save/invest in an RRSP?

The amount of money allowed to be saved in RRSP is either 18% of the earned income in the current year or allowed maximum, whichever is lower. This money can be invested and will grow tax free, for many years until retirement time. When the owner of the account is retiring, the RRSP will be converted to a RRIF (Registered Retirement Income Fund). Conversion of an RRSP to an RRIF may be done at any time, but not later than the year when the owner turns 71. Payments (withdrawals) from an RRIF will start the year after the conversion, and at the latest when owner is 72 years old. There is a mandatory minimum withdrawal payment per calendar year.

Is there a deadline for RRSP contributions?

I like to say that RRSPs are a year-round service because the contributions can be made at any time. However, there is a deadline for RRSP deposits which has to do with claiming your contributions at tax time, to be deducted from your annual income and as such create a tax savings.

To be claimed with the submission of your tax return for the year before, RRSP contributions must be deposited in the account no later than 60 days from the beginning of the current year (January 1st). The date may be the end of February or the beginning of March, depending on whether the year is a “leap year” or not.

Can I withdraw money from my RRSP before I retire?

The government does allow for the RRSP money to be used for other purposes before retirement. Buying a house for the 1st time (or after not owning a personal residence for at least 5 years) will entitle the owner to borrow up to $25,000 from their RRSP tax-free, and re-deposit the funds within the following 16 years. Another possible use for RRSP money is to fund LifeLong Learning education (due to changing carreers or enhancing your needed level of education). Canadians can withdraw (borrow) up to $20,000 for this purpose and pay it back into the RRSP over the following 10 years.

Withdrawal of money from the RRSP for any other purpose will be subject to taxation at the marginal tax rate, and the amounts of money taken out cannot be put back.

What is a TFSA?

TFSA stands for Tax Free Savings Account and has been in existence in Canada since 2009. It has been created with the goal of supplementing the growth of a nest egg for retirement income. It is a generous plan which is much more flexible than the RRSP as it allows the owner to grow their investments tax free (like the RRSP), but the funds can be withdrawn at any time, for any purpose (different from the RRSP), and the amount withdrawn is saved as “contribution room” for a future time when it can be put back into the account (different from the RRSP). Investments can be equities, bonds, GICs, mutual funds or ETFs. An important difference from the RRSP is that TFSA contributions are after tax money and the funds are not deductible from your earned income for purpose of calculating taxes.

How much money can I save/invest in a TFSA?

The TFSA has a “contribution room” that is limited annually to an accumulating maximum amount; for the years 2009 - 2012 it was $5,000, for 2013 2014 it was $5,500, for 2015 it was $10,000, for the years 2016,  2017&2018 it was  $5,500, and for 219 and 2020 it is $6,000. For a Canadian who has never contributed to a TFSA, there is $69,500 in contribution room available as of January 1st, 2020.

Money withdrawn from a TFSA is never taxed, and the “contribution room” saved is equal to the amount withdrawn, not to the initial contribution amount. For example, if you invest $5,000 and it grows to be $7,000, and you then withdraw $7,000, this $7,000 is the “contribution room” allowed to be put back in at the start of the following year.

It is a powerful way of saving and growing your money tax free.

Is there a deadline for TFSA conributions?

There is no deadline for the TFSA contribution. It may be made any time as long as the rules for the accounts are followed. Contributions not made are carried forward to the next year, and accumulates as additional available contribution room.

There is a penalty for over-contribution in a TFSA. Like the RRSP over-contribution, you will be penalized with charges of 1% of the amount of over-contribution, per month.

Your NOA (Notice of Assessment) sent by CRA should reflect both your RRSP and your TFSA contribution room available.

RRSP and TFSA – which one is better for ME?

The rule of thumb (ROT) that I use with my clients is as follows:

  • Save/Invest in a TFSA when your annual income is less than $40,000 (because the tax savings/deferral of your eventual RRSP contribution is too small)
  • Save/Invest in an RRSP when your annual income is higher than $60,000 (because your tax savings/deferral is more significant)
  • Save/Invest in either a TFSA or RRSP as per your personal preference when your income is between $40,000 and $60,000. The best for YOU cannot be decided just by following the ROTs.

Each of us has personal circumstances that must be accounted for. Certainly, there may be many questions that you have after reading all of this information... questions which have not been addressed here.

I strongly encourage you to be bold and call me to ask such questions. You may discover some opportunities to make money that you did not know exist. You may be able to help fulfill a dream that you have. You never know.

It is never too late to learn something new!