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RRSP vs TFSA

By Laura Southall CFP® CLU® Senior Wealth Advisor

The Southall Group

Assante Financial Management Ltd


What is the difference between the RRSP and the TFSA and which should I choose?


Before we discuss the difference between the RRSP and the TFSA, let’s define each of these investment accounts. The RRSP is a Registered Retirement Savings Plan and the TFSA is a Tax-Free Savings Account.


Registered Retirement Savings Plan (RRSP)

The RRSP is the most commonly used and understood investment account. It is generally used to save for retirement, though you can withdraw up to $35,000 tax-free for the purchase of a first home or up to $20,000 tax-free for post-secondary education costs.


When you contribute to the RRSP, you receive a tax deduction. This means that you don’t have to pay income tax on the money that you contributed to the RRSP. Often you have already had taxes withheld from your income, so it usually means that you get money back when you file your taxes. Once invested, your money will grow inside the RRSP, and you won’t pay any tax as the money grows. Keep in mind that when you withdraw your funds in the future, that is when the taxation will kick in. A withdrawal from an RRSP is taxed as earned income.


The main benefit of the RRSP is to lower the taxes you pay at an earlier stage in your life, shifting the tax to retirement when your tax rate won’t be as high.


Things to know about the RRSP:

  • When you contribute to your RRSP, you will get a tax deduction, which normally means you get money back when you file your taxes.

  • You do not pay any tax while your money grows inside the RRSP.

  • You pay income tax when you withdraw from the RRSP.

  • You earn RRSP contribution room each year. 18% of your previous year’s earnings becomes your contribution room and this accumulates if it is unused.

  • When you reach December 31st of the year you turn 71, you must stop contributing to your RRSP. At this point you are required to transfer your RRSP holdings to a RRIF, a Registered Retirement Income Fund. A minimum annual withdrawal is enforced by the Canada Revenue Agency, calculated depending on your age and the amount in the RRIF. Each of these withdrawals are taxed as income.


Tax-Free Savings Account (TFSA)

The TFSA is another type of investment account which can be used for short or long-term goals and is more flexible than the RRSP. As the name suggests, none of the money you deposit, or any of the earnings inside the TFSA, will ever be taxed, though you do not receive a tax deduction when you contribute. This is an excellent way to build your savings, though there are some conditions. There’s a limit to how much you can contribute each year—as of 2023, that limit is $6,500, and will be $7000 for 2024.


With the TFSA, your contribution room starts to accumulate each year, from the moment you turn 18, regardless of whether you’ve opened the account. Because the TFSA was introduced in 2009, anyone who was 18 in 2009 has $88,000 in contribution room in 2023.


It is important to understand that if you are 50 years old, you could have $150,000 in your TFSA, because you have contributed the maximum each year, and you have invested it. The limits only apply to contributions, not growth.


Also, if you have withdrawn from your TFSA, your contribution room resets the following calendar year, so you always have your contribution room even if you have used it and then withdrawn.


Things to know about the TFSA:

  • When you contribute to your TFSA, you will not get a tax deduction.

  • You do not pay tax on the growth inside the TFSA or when you withdraw from the TFSA.

  • You earn contribution room each year and this room accumulates. If you withdraw your contribution room resets for the following year.

  • You can withdraw from your TFSA at any time and there will be no tax implications.


So which account should you choose?

In an ideal world you are maximizing your contributions to both accounts. You are contributing your annual contribution room to your RRSP for retirement, and you are maximizing your annual contribution to your TFSA.


If maximizing both accounts is not realistic, you could divide what you can contribute between the two accounts, so that you are still saving for retirement in the RRSP, but also have some money in a TFSA that is accessible without tax implications.


If you are picking one of the accounts, the next step is to look at your goals. If your goal is long term savings and minimizing your taxes, then the RRSP is the right option for you. If your goal is shorter term like saving for a car or trip, then the TFSA is right for you. The TFSA is much more flexible because you can take money out at any time, for any purpose, without paying tax. The RRSP is less flexible because you would only want to take money out when you are in a low tax bracket, which is usually in retirement. The benefit to the RRSP is the tax deduction you will get when you contribute.


If you aren’t sure of your goals and you just want to begin investing, start with the TFSA, and you can always contribute to the RRSP later once you have established your TFSA. The most important thing is to start investing.


Both the TFSA and RRSP are investment accounts, designed to help you reach your goals. Each has its own benefits and drawbacks. Depending on your goals and situation, pick one or both for your investments.


 

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Laura Southall is a Senior Wealth Advisor with Assante Financial Management Ltd. The opinions expressed are those of the author and not necessarily those of Assante Financial Management Ltd. Please contact her at (613) 877-3992 or visit www.laurasouthall.com to discuss your particular circumstances prior to acting on the information above. Assante Financial Management Ltd. is a member of the Mutual Fund Dealers Association of Canada.









 

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