Jan 24, 2020
A quick guide to TFSAs & RRSPs
RRSPs and TFSAs: a guide to navigating the differences
How much, why and how you save your money is deeply personal. Choosing from the variety of saving and investment products available depends on understanding your financial goals and options, both now and for the future.
A savings strategy for someone who is close to retirement looks very different compared to someone who’s just entering the workforce. Likewise, if your main goal is buying your first home, you'll want to make different financial choices than an entrepreneur who is looking to start or build their business.
The important thing is to save your money where it’s going to work best for you.
If you’re thinking of starting to save – or want to improve your current savings plan – you may want to consider an RRSP, a TFSA, or a combination of the two. Both are great tools for saving that can be used separately or together. But how you use them depends on why you're saving money.
Key differences at a glance
An RRSP and a TFSA are both registered plans. There are two key differences between the two products:
- Contributions to an RRSP are made pre-tax and can be used to reduce your income, which in turn reduces the amount of tax that you pay. Contributions to a TFSA are made after-tax and therefore will not impact your income tax, however your contributions can grow tax-free.
- Withdrawals from an RRSP are taxed. The idea with an RRSP is that you may be in a lower income bracket when you retire, meaning you would pay less tax on those dollars than you would have when you earned them. Withdrawals from a TFSA are not taxed, as you already paid tax on these dollars.
A deeper look at the differences
A Registered Retirement Savings Plan (RRSP) allows you to contribute funds into a registered plan before being taxed. Contributing to an RRSP provides a tax deduction so that the amount you contribute lowers your taxable income. Your money can grow ‘tax-free’ within the RRSP, but you will pay taxes when you withdraw funds from the account.
An RRSP is primarily designed to help Canadians save for retirement, but funds can be accessed earlier in some situations, like through the Home Buyers' Plan or the Lifelong Learning Plan, subject to eligibility and conditions.
A Tax-Free Savings Account (TFSA) is a registered savings plan. However, it’s not ‘just’ a savings plan; it’s a way to invest your money through a range of options and securities including cash, stocks, bonds, mutual funds, and GICs.
TFSAs allow you to grow your money tax-free within the plan, meaning you aren't taxed on contributions, interest earned, dividends or capital gains. Also, funds can be withdrawn from your TFSA tax-free.
A TFSA is designed to help you save money for any goal, including big ticket items like a new home or vehicle, travel plans, a wedding, or longer-term planning for retirement.
How and if contributions grow depend on the investments you hold within the RRSP or TFSA. These can include stocks, bonds, GICs, mutual funds, exchange-traded funds, index funds, cash, gold and silver bars and income trusts.
Canadians can contribute directly to both an RRSP and a TFSA. However, it's critical to remember that there are contribution limits for both.
Contributing to an RRSP:
In 2020, the RRSP contribution limit is 18 per cent of your previous year’s earned income, up to the maximum amount of $27,230 (a number set each year by the CRA, subject to any pension adjustments).
Like a TFSA, you can carry your RRSP contribution room forward to future years if you’re not able to contribute the annual maximum.
As an example, let’s assume your RRSP contribution limit was $26,500 in 2019 but you didn’t contribute any money into the RRSP. You would automatically carry that contribution room forward into the next year. So, if in 2020 your contribution limit is $27,230 (the maximum amount), combined with the amount you carried forward from 2019, you could contribute up to $52,730. Don’t forget, if you participate in an employer pension plan, those contributions may have reduced your RRSP limit.
There’s no limit to the number of RRSP accounts you can have – just the amount you can contribute – so if you have multiple RRSP accounts, you might want to talk to an advisor about whether consolidating your accounts makes more sense for you.
Like a TFSA, over-contributions to an RRSP will be penalized. Generally, the CRA gives a bit of ‘wiggle room,’ but, if you’re over by more than $2,000, be prepared to pay a one per cent tax per month on the excess amount. For more information about what happens if you go over your RRSP deduction limit, visit the CRA website.
Contributing to a TFSA:
Annual maximums for contribution can vary from year-to-year. For 2020, the maximum annual contribution limit is $6,000. The current lifetime contribution limit (from 2009 to 2020) adds up to $69,500 (for Canadians who have been 18 years old and residents of Canada for all eligible years and have made no contributions up to now). Previous annual limits can be found here.
Just like RRSPs, you can have more than one TFSA. However, your total contribution limit doesn’t change. Remember that’s $6,000 for 2020 regardless of whether you’re investing in one account or spreading it across several. The same is true with financial institutions – the TFSA limit is $6,000 for 2020 whether you're investing at one financial institution or at several.
Contributing too much money to a TFSA can be too much of a good thing – and it will cost you. The difference between your limit and your contribution amount is subject to a monthly one per cent penalty tax.
For example, let’s assume you contributed $1,000 more than your available limit. You would be assessed a $10 penalty (1 per cent of $1,000) for every month you exceeded the limit. If it takes you six months to move the money out of the account, your penalty would be $60 ($10 / month multiplied by six months). More information on over-contributing can be found on the Canada Revenue Agency's website.
If you have a spouse, you can contribute to a spousal RRSP. Contributions made to a spouse's or common-law partner's RRSP reduce your contribution room. Also, while you can't contribute directly to your spouse's TFSA, you can give them money towards their own. For additional information, the Canada Revenue Agency offers examples of how spousal contributions are treated.
Both products allow you to take out money when you need it (subject to any restrictions in the investments chosen), but again, there are considerations.
With a TFSA, you are not taxed on withdrawals (because you've already paid tax on the money you deposited) and the withdrawal amount is added back to your contribution room at the start of the following year.
Withdrawals from an RRSP are taxable. At retirement, money withdrawn is taxed at your marginal rate (your marginal rate is the combined federal and provincial taxes you pay on income at tax time). While you pay taxes on RRSP dollars eventually, you are likely to be in a lower income bracket at retirement, reducing the amount of tax you pay on these dollars.
Withdrawals from an RRSP are generally subject to tax. However, under the Home Buyers' Plan, first-time homebuyers can withdraw up to $35,000 (or $70,000 total for a couple withdrawing $35,000 each from their respective RRSPs) to finance a down payment, subject to eligibility and conditions. The withdrawal is tax-free but must be paid back into your RRSP within 15 years.
Once you turn 71, any money in your RRSP must be withdrawn, converted to a retirement income fund or used to purchase an annuity no later than December 31 of that calendar year.
More information on RRSP withdrawals at maturity is available on TD's website.
Death and taxes
As the saying goes, both are unavoidable, making it extra important to understand the ramifications of both when it comes to your finances. Should you pass away before withdrawing or converting your RRSP, there may be an opportunity to pay less tax by taxing the funds in the hands of a qualified beneficiary rather than the deceased. A qualified beneficiary for this purpose generally includes a spouse or common-law partner, financially dependent children or grandchildren under the age of 18, and disabled children or grandchildren of any age. In some cases, such as where the beneficiary is a spouse or common-law partner, it may also be possible for the qualified beneficiary to contribute the amount received into their own RRSP, effectively deferring tax on the entire RRSP balance until the amount is withdrawn by the beneficiary.
Because a TFSA is funded with after-tax dollars, there are no withdrawal taxes, however you may want to talk to an advisor about what happens to your TFSA after your death to understand the potential implications, such as the potential application of probate taxes.
Generally, there are two options for the distribution of a TFSA: you can name a ‘beneficiary’ (spouse/common-law partner/anyone else) or a ‘successor holder’ (spouse or common-law partner). A ‘successor holder’ means that instead of having all the assets liquidated and transferred, they can take over the existing TFSA account. A beneficiary also receives the TFSA tax-free, but there is tax payable if the account rises in value from the date of death to the date that the funds are transferred.
The key differences between an RRSP and a TFSA mainly come down to contribution limits, withdrawal implications, and how and when you pay taxes on the funds.
Not sure where to start or which product is best for your needs? The scenarios below may help you figure out your best approach.
“Albert” is a 45-year-old mechanical engineer working for a medium-sized company, making a six-figure salary. He's hoping to retire at age 65 and spend more time travelling and being with family. While he makes good money today, he knows his income will be lower in retirement.
Albert should think about an RRSP because he has a long-term (20-year) financial goal and is currently in a higher tax bracket. By contributing to an RRSP, Albert will lower his taxable income, while still investing towards his goal for the future.
If Albert’s work situation was different – for example, if he owned his own business and was drawing a modest salary but expecting his company to grow significantly before he retired at age 65 – an RRSP may not be the best option. In this scenario, he may want to look at a TFSA.
Although Albert is saving for retirement in both scenarios, in the second, his current income is lower today than when he plans to retire, making a TFSA potentially more advantageous.
“Sam” is a 28-year old marketing associate at a large company earning an annual income of $60,000. Their primary goal is to buy a home. However, Sam regularly takes money out of their savings for lifestyle expenses, while worrying they'll never be able to afford to save for a home or longer-term goal, like retirement.
An RRSP might be the way to go for Sam. An RRSP would help them save for retirement and they'd be eligible to use the funds for a down payment under the Home Buyers’ Plan, subject to eligibility and conditions. Additionally, they'd likely be less inclined to withdraw money for other expenses because of tax implications.
If Sam sticks to a savings strategy, they may want to also start a TFSA. A TFSA would still help them save for a down payment, but also allow them to withdraw money in case of an emergency, without incurring tax.
Questions? Remember we’re here to help.
To get started, reach out to us online, in person or by phone. We can work with you to create a plan that will help you reach your savings goals and feel financially confident.
If you’re a TD customer, book an appointment online to speak to us in person. Or give us a call (1-888-568-0951) and we can help answer your questions.
For more information:
The Canada Revenue Agency offers lots of information about registered plans on its website.
You’ll also find more information about savings and investing at TD on our website.