The Tax Free Savings Account (TFSA) and the Registered Retirement Savings Plan (RRSP) are two of the most popular Canadian investment vehicles. They both provide a great way to save money for the future and they both shelter your investments from tax.
“The TFSA and RRSP are basically like two separate boxes,” says Montreal-based Jamal Khalil, BMO Regional Investment Manager for Quebec. “They’re vehicles into which clients can put whatever type of investment they want. And they’re both powerful savings tools in their own way.”
Who can contribute?
TFSA: Anyone who is at least 18 years old, and who has a valid Social Insurance Number, can open a TFSA and start contributing to it.
RRSP: Anyone who has reported earned income in a tax return can contribute to an RRSP. That means teenagers with part-time or summer jobs can start saving for their future. You can contribute to an RRSP until December 31 of the year in which you turn 71.
How much can you contribute?
TFSA: Since TFSAs were introduced in 2009, the annual contribution limit was set at $5,000 per person. In 2013, that amount jumped to $5,500. You’re also allowed to carry forward any unused contribution room from previous years. For example, if someone opens a TFSA in 2013 and has never had one before, she can contribute $25,500 in 2013.
RRSP: For 2013, the maximum RRSP contribution amount is $23,820, or 18 per cent of your 2012 income, whichever is lower. Like the TFSA, you’re also allowed to make RRSP contributions for previous years when you weren’t able to contribute the maximum to your plan.
What do they hold?
TFSA and RRSP: Don’t let the words “savings account” fool you into thinking TFSAs are just a place to park cash. TFSAs and RRSPs can hold the same types of investments: stocks, bonds, mutual funds, Guaranteed Investment Certificates (GIC), Exchange Traded Funds and cash are the most common.
Where do the tax savings happen?
TFSA: Unlike with most other investments, investment returns earned within the shelter of a TFSA are not taxed, ever. Whether you earn a 1.5 per cent rate of return on a GIC or 10 per cent on a stock that performs well, your original contribution and your returns are yours to keep.
RRSP: For every dollar that you contribute to an RRSP, you deduct that amount from your taxable income. For instance, if you earned $45,000 in 2012 and contributed $5,000 to your RRSP for that year, you would only pay income tax on $40,000. The tax savings often come in the form of a tax refund after filing a tax return.
What happens when money is withdrawn?
TFSA: You can withdraw funds from a TFSA at any time, with no penalties. However, you will have to wait until the next calendar year to contribute again, if you had already reached your maximum contribution for the year. For example, if you contribute $5,500 in February and withdraw $2,000 in July, you can’t contribute any more until January of the next year, when you’ll be able to contribute $5,500 plus the $2,000 you withdrew.
RRSP: When you withdraw funds from your RRSP you pay tax on those funds, based on your marginal tax rate. However, if you are already retired, your tax rate should be relatively low and the penalty will be negligible.
Funds can also be withdrawn from an RRSP with no tax repercussions if they’re used by a student to fund an education or if they’re used by a first-time home-buyer for a down payment. In both of these cases, you’re borrowing from your RRSP and will have to return the funds to the plan in a specified amount of time.
Which is better for me?
TFSA: The TFSA is ideal for shorter-term savings goals, although there’s no reason why it can’t be used to save for retirement, as well.
“With the exception of HPB (Home Buyers’ Plan) and LLP (Lifelong Learning Plan), if the client’s objective is really short term, like three to five years, then it makes no sense to save in an RRSP, use up that RRSP contribution room, take the money out again and get taxed on it,” Khalil says. “It’s better to put it in a TFSA.”
RRSP: This tried-and-true plan was custom built for retirement savings, and that’s what it’s best suited for. With more contribution room than TFSAs and the carry-forward room allowed, RRSPs can hold a large chunk of your retirement fund.
“It’s never black or white,” Khalil says. “It’s always best to consult a financial planner or investment advisor because together you can look at your investment time horizon, your goals, your risk tolerance and then decided what vehicle is the best fit and what products to use in that vehicle.”