So you’re finally generating enough income to think about the future, not just tomorrow. What’s the right way to save?
Registered Retirement Savings Plans (RRSPs) and Tax Free Savings Accounts (TFSAs) are two of the most popular long-term tools for saving and growing your money. You can fill them up with cash or all sorts of investments, including stocks, bonds and guaranteed investment certificates.
Reliable RRSPs have been around since the ’50s, giving Canadians the chance to put off paying taxes until retirement. Then flexible TFSAs came around in 2009, allowing people to grow their money tax-free until they’re ready to spend it on whatever they want.
So which one is right for you? TFSA? RRSP? Both? Keep these differences in mind:
When can I open an RRSP or a TFSA?
When it comes to signing up, TFSAs only have two requirements. You must be 18 years of age and have a valid social insurance number. You don’t need to have an income or be employed to qualify.
There’s no age requirement when it comes to signing up for an RRSP. You can be 16 or 60; the only prerequisite is that the owner of the account must have an income and a social insurance number and file yearly tax returns in Canada.
How much can I contribute?
The contribution limit for TFSAs is $6,000 per year. The limit follows inflation but tends to only move in $500 increments every few years. The $6,000 figure has been in place since 2019, up from $5,500 in 2018.
On the other hand, the limit for RRSPs changes every year and is typically much higher. The limit for 2020 is $27,230 or 18% of your income — whichever happens to be lower.
If you don't want to worry about exceeding your limit, you can set up your TFSA or RRSP with a robo-advisor, which will autmotically make your contributions for you and make sure you don't go over.
Both types of accounts allow you to roll over your contribution limits to the following year. If you don’t make the maximum contribution to your TFSA or RRSP by the end of the year, your contribution limit will increase next year, the year after that and so on.
Both types are eligible for employer sponsorship, as well. Depending on where you work, your employer may offer to match the amount you contribute each year, up to a certain amount.
When is my money taxed?
TFSA contributions are made with “post-tax” dollars. You’ll pay income tax on the money that goes into your account and won’t be able to write off your contributions when filing season comes around. On the bright side, when you go to withdraw the money, you won’t have to pay taxes a second time.
With an RRSP, you make all of your contributions with “pre-tax” dollars. Yes, you’ll pay income tax up front, but your contributions can be written off during filing season, netting you a tax credit. However, you have to pay taxes sooner or later — and in this case, it’s later, when you withdraw the funds.
That’s the key to RRSPs. You’re only taxed on the money when you’re retired and likely in a much lower income-tax bracket. You’ll save a bundle.
Will my money be taxed in the account?
Nope. Welcome to the beauty of TFSAs and RRSPs: All of the interest, dividends and earnings made in either account are completely shielded from taxes, which means the money you invest today could grow radically over the next 20, 30 or 40 years.
And any money you earn in a TFSA or RRSP doesn’t count against your contribution room for that year.
When can I withdraw my money?
TFSAs allow a lot of freedom. If you’re ready for that big purchase — or your car breaks down and you need to dip into your savings — you can take money out of your TFSA at any point without penalty.
The only caveat is that you won’t be able to put that cash back in without using up some of your contribution room for that calendar year. You will, however, be able to resubmit that money the following year.
With an RRSP, your money is pretty much locked away until you decide to retire.
If disaster strikes before then, you can cash out some money early — but it’s going to hurt. Not only will your savings be subject to income tax upon withdrawal, you’ll permanently lose that contribution room and suffer an additional “withholding tax” for pulling cash out.
Outside Quebec, you’ll pay a 10% withholding tax on withdrawals up to $5,000, 20% on withdrawals between $5,000 and $15,000 and a whopping 30% on withdrawals over $15,000.
Can I use my savings to pay for tuition or buy a house?
You certainly can.
Again, with a TFSA, you’re granted total flexibility. You can withdraw as much as you want for any reason. Just keep in mind that you’ll lose the contribution room for that year.
With an RRSP, you can only withdraw your money without penalty under three circumstances. The first is when you retire. The other two are for tuition or a home.
The Lifelong Learning Plan is a government program that allows you to use up to $20,000 from your RRSPs — a maximum of $10,000 per year — for tuition and living expenses when going back to school. Once you graduate, you have 10 years to repay the money you took out of your account.
You don’t have to pay any interest on the money you used, but failing to pay it back will result in a tax hit for the amount you did not repay.
A similar program exists to help people buy their first home. The federal Home Buyers’ Plan allows you to withdraw $35,000 from your RRSPs ($70,000 if you’re a couple) to pay for your first home.
The withdrawal is not taxable, as long as you commit to repaying the full amount in 15 years. If you miss a payment, the government will treat the amount you missed as income for that year, and you’ll be taxed on it.
When do I have to take my money out, and what should I do with it?
While you shouldn’t pull money out of an RRSP early if you can help it, you actually have to start taking income from it eventually — specifically, by the end of the year you turn 71. At some point before then, you’ll have to either:
withdraw the cash in a lump sum. Keep in mind, this is still subject to withholding tax, and taking a lifetime of savings out at once would result in a very large income-tax bill.
use the funds to purchase an annuity, which will act like a pension and pay you a fixed amount each year
convert your RRSP to a Registered Retirement Income Fund (RRIF). An RRIF will look a lot like your old RRSP, but you can only make withdrawals instead of contributions and you’ll have to withdraw a certain percentage each year.
Or you can do some combination of the three. You could even put some of it into a TFSA, if you have the room.
With a TFSA, you can keep contributing to your account indefinitely, and you won’t face a penalty for withdrawing at age 71, 81 or even 91.
Which one do I choose?
When it comes to choosing between a TFSA and an RRSP, you can either close your eyes and go, “Eenie, meenie, miny, moe,” or take a serious look at your long-term goals. We suggest the latter.
Generally, if you’re content to lock away your money until retirement and can contribute a fair amount, RRSPs bring the biggest benefits.
If you have less to save and suspect you may need to dip in at some point in the future, a TFSA might be better. Undecided investors will also have peace of mind knowing they can change their mind later without penalty.
Or you can use both at the same time. Maybe you want to max out your TFSA and put whatever else you can spare in an RRSP. Or put the bulk of your money into an RRSP while using a TFSA as a small emergency fund.
Whichever route you choose, know that you’re making a smart decision simply by saving for the future.