Financial Planning Services Mississauga, Ontario
Mississauga Insurance Agent
My goal is to alleviate you from stress in finding the best option that will save you in interest payments, make your savings work harder and protect your income earnings. Ultimately, helping you to leave a legacy behind.
RRSP VS. TFSA
The two most common ways to save are TFSAs and RRSPs. This then leads to two of the most common investment questions:
- “What’s the difference between RRSP and TFSA accounts?” and
- “Should I choose a TFSA or RRSP?”
The fact is, both plans offer tax advantages and opportunities for growth. Understanding the differences is what will help you decide and make the most of your savings. Whether you start with an RRSP or TFSA depends on factors like your reason for saving, your time horizon, and your current and future tax rates. Below we offer an in-depth RRSP and TFSA comparison to help you make the right call.
TFSA Vs RRSP
The major difference between RRSP and TFSA accounts centers around tax implications. RRSPs offer a tax deduction when you contribute, but you have to pay tax when you withdraw the money. TFSAs offer no up-front tax break, so you don’t pay tax on any withdrawals, including growth. Therefore, earnings within both accounts grow tax-sheltered, which helps you reach your savings goals faster than a simple savings account. Both accounts also allow you to carry forward unused contribution room. But beware: both have penalties for over-contributing.
Here are important factors to consider when choosing a TFSA or RRSP.
| FAQ | TFSA | RRSP |
|---|---|---|
| When did the federal government establish the account? | 2009 | 1957 |
| What are the age restrictions? | Anyone 18+ can open an account. | Anyone up to age 71, with earned income and a filed tax return can open an account. |
| What are the annual contribution limits? | Currently 6,500.2 Limits change periodically. | 18% of your income, up to a maximum of $30,780.3 |
| Can you carry unused contribution room forward? | Yes | Yes |
| What are the penalties for over contributing? | Penalty tax of 1% per month on the excess funds. | Penalty tax of 1% per month on the excess funds. |
| What are the tax advantages? | Your money grows tax-free; you pay no tax on withdrawals. | Your money grows tax-sheltered, with taxes deferred. Contributions are tax deductible and can be deferred for a future tax break. |
| What are the tax disadvantages? | Contributions are not tax deductible. | You must pay tax on withdrawals. |
| What are the withdrawal rules? | Tax-free, at any time and for any purpose (subject to any specific investment terms). | At any time and for any purpose. Withdrawals are taxed as income unless used for your first home or continued education. You must convert the funds to a RRIF or annuity by age 711 and pay tax on income you withdraw |
| Can withdrawals be re-deposited? | Yes; after a withdrawal, contribution room is adjusted and re-added in the next year | No, unless related to the Lifelong Learning Plan or Home Buyers’ Plan. |
| Can you name a beneficiary? | Yes | Yes |
| Can you benefit by contributing to your spouse’s account? | No. TFSA accounts belong to individuals. | Yes. You can contribute in your spouse’s name and enjoy a tax benefit. |
Wait, Wait! Why not invest in both accounts?
Good question. Since both plans provide tax-sheltered growth, maximizing your allowable RRSP and TFSA contributions – if you’re able – we can help you reach your savings goals that much faster. But, if investing in multiple accounts isn’t realistic, here’s how to know which account you should open first.
TFSA vs RRSP: the choice
Ultimately, the best way to choose an RRSP or TFSA is to compare your current marginal tax rate (the percentage of income tax you pay each year) to the rate you expect to pay in retirement. This involves a little thinking and calculating, but it can help you save a lot of money.
First, get a sense of how you want to live in retirement. Do you want to travel, learn new skills, indulge in hobbies? Or are you content to maintain or lessen your current standard of living? Second, estimate how much your retirement plans, along with your regular living expenses, will cost each year. Third, when you have an idea of your annual retirement income needs, check to see how much tax you’ll pay. Remember to include both federal and provincial taxes. For example, compared with your current tax rate, do you predict that you’ll have:
- a lower tax rate in retirement? You may want to start with an RRSP.
- a higher tax rate in retirement? You may want to start with a TFSA.
- the same tax rate in retirement? You may want to start with a combination of the two, even if you’re not maximizing your annual contribution limits.
DIFFERENCES BETWEEN TFSA AND RRSP
If you are looking to save in the most tax-efficient way, TFSAs and RRSPs can both be an effective option to achieve your savings goals. However, each plan has its own distinctive features. RRSPs can be an excellent complement to your TFSA.
| FAQ | TFSA | RRSP |
|---|---|---|
| What is the primary purpose? | Short-term general savings or long-term retirement savings | Retirement savings |
| Are contributions tax-deductible? | No | Yes |
| Are contributions made with after-tax dollars? | Yes | No, contributions are made with pre-tax dollars |
| What is the tax treatment of earnings inside the account? | Tax Free | Tax Deferred |
| Can I make a withdrawal at any time? | Yes | Yes, but withdrawals are taxed as income |
| Is there tax on withdrawals? | No | Yes, but withdrawals are taxed as income |
| Do withdrawals increase contribution room? | Yes | No |
| Does unused room carry forward? | Yes | Yes |
| Is there an age limit? | No | Yes, to a RRIF or life annuity by age 71 |
| Do income attribution rules apply? | No | Generally no, but may apply to withdrawals from a spousal RRSP |
| Do withdrawals affect income-tested government benefits and tax credits | No, generally withdrawals are not included in taxable income | Yes, generally withdrawals are included in taxable income |
| What is the contribution room limit/formula? | $6,000 per year regardless of income (2021) plus, available TFSA contribution room | 18% of earned income to a maximum of $27,830 (2021), plus unused RRSP deduction room |
With a better idea of how RRSP and TFSA accounts compare, what’s your next move?
Still have questions on:
- Whether an RRSP or TFSA is right for you?
- The best way to get money out of your RRSP?
- How much and when to contribute?
- Anything else RRSP related?
We can help!
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