If you’re starting to save money, you’re probably asking yourself “What is the difference between a TFSA and an RRSP?”
Well, luckily for you, we have a Wealth and Estate Planning expert on our team to tell you all about it.
What are TFSAs?
A Tax-Free Savings Account (TFSA) is, in broad terms, a flexible investment account. It’s not really a savings account at all, at least not in the traditional sense. A TFSA allows you to put in any type of investment. From stocks and bonds to your personal cash, you can invest and save however you want with a TFSA. You can then withdraw the money whenever you want, without paying tax on the gains. So sure, it works like a savings account in that you can withdraw from it when you need to. But it’s really a way to put your money to work that would otherwise just be sitting in a regular savings account, growing at a rather dismal interest rate.
The Benefits of TFSAs
When the Canadian government introduced the TFSA program in 2009, it did so to incentivize people to save for retirement, a home, or other major life events. The government decided to help you out with that and make TFSA’s “tax-advantaged” accounts. That means the money you make on investments through your TFSA and the interest that the cash makes won’t be taxed when you withdraw it to buy that first home or take a trip to the French Riviera when you retire.
The Drawbacks of TFSAs
So far, we’ve made TFSAs sound pretty dreamy, but there are limits to the so-called “tax advantage”. For example, the government places contribution limits on TFSAs, and these change year-to-year. In 2021, you can only to contribute up to a maximum of $6,000, and you’ll face a fee of 1% of the amount over that limit every single month. If you’re planning on making big moves in the investment game or you have a lot of excess cash laying around, using a TFSA as your main registered investment account might not be the best, and you may want to think about contributing to an RRSP instead.
What are RRSPS?
A registered retirement savings plan (RRSP) is a cheat code for tax. No exaggeration. The government created the RRSP program to incentivize people to save for retirement and to not entirely rely on Canadian Pension Plan benefits, and to keep you paid while you age, they made RRSPs “tax-deferred” accounts. That means any money you contribute to an RRSP (up to the contribution limit) in a given year will be subtracted from your total taxable income for the year. But, and this is a big but, you won’t be able to withdraw cash from your RRSP until you retire. You shouldn’t let that scare you off though. At some point you will retire, and you will want some savings to fall back on. Plus, those tax breaks when you contribute are pretty sweet.
The Benefits of RRSPs
It’s all about the breaks, baby. Not only do you have a great way to save for your retirement, but you actually get a huge break on your taxes when you contribute. Say you’re on track to make $80,000 this year, but you contribute the maximum 18% contribution limit. You can deduct $14,400 from your taxable income for the year and miss out on all of those taxes. There’s also a little thing called the Homebuyers’ Plan, which allows you, if you meet the criteria, to make a tax-free withdrawal from your RRSP of up to $35,000 to use a down payment on your first home. However you will have to pay the full balance of the withdrawal back into your RRSP within a 15-year period.
The Drawbacks of RRSPs
The main drawback of an RRSP comes from the limits on withdrawals. Homebuyers’ Plan excluded, you won’t be able to touch your RRSP cash until you’re 55. When you hit 55, you’ll be able to covert your RRSP to a Registered Retirement Income Fund (RRIF). With an RRIF, you can start to investment your RRSP cash and earn money in your retirement. There are certain circumstances that allow you to get around that age limit, like financial hardship in certain provinces. It is best to think about your RRSP as being completely locked-in until you’re 55 or until you retire, though.
Let’s Recap
- The main difference between TFSAs and RRSPs is access: you can invest in and withdraw from a TFSA with near total freedom, while an RRSP is much more limited.
- TFSAs have a lower contribution limit than RRSPs, however both have very specific contribution limits.
- A TFSA are more of an investment account than a traditional savings account.
- You can only contribute cash savings to an RRSP.
- Contributions to RRSPs are tax-deductible.
- A TFSA is a great option if you think you may need access to the funds before you retire.
- You cannot (in most circumstances) invest or withdraw your RRSP funds until age 55.
