Are you looking to save for the future while getting a tax break? TFSAs and RRSPs both offer tax advantages that can help you reach your saving and investment goals. But which one is right for you?
In reality how you should protect your income isn’t always clear, but your savings plan can include a TFSA, RRSP or both. If your financial situation means that you must choose one over the other, then it is important to understand how they differ.
Here are some important points to help you choose which option is right for you.
Comparing RRSPs and TFSAs
- Primary Use – RRSPs are typically used as retirement savings. TFSAs can be used to save for any purpose.
- Eligibility – You can contribute to an RRSP after you start earning income from employment or certain other sources. To open a TFSA, you must be at least the age of majority.
- Contribution Limit – The 2022 contribution limit for a TFSA is $6,000. Your 2021 RRSP contribution limit, on the other hand, is 18% of your earned income reported on your 2020 tax return or $27,830 – whichever is lower, subject to certain adjustments.
- Unused Contribution Room – Your unused contribution room is carried forward for RRSPs & TFSAs.
- Withdrawals – RRSP withdrawals are taxable, subject to certain exceptions. With a TFSA, you can withdraw money any time, tax-free!1
- Withdrawn Amounts – When withdrawing funds from an RRSP, your contribution room is lost for amounts you withdraw subject to certain exceptions. For a TFSA, withdrawn amounts are added back to your contribution room in the following year.
- Taxation – Contributions made to your TFSA are not tax-deductible. RRSP contributions are tax – deductible. This means any contributions you make may reduce the amount of tax you pay on your personal income.
- Plan Maturity – An RRSP matures at the end of the calendar year in which you turn 71. There is no upper age limit for a TFSA.
- Spousal Plan – You can contribute directly to a spousal RRSP. There are no spousal TFSAs.
What is your savings goal?
Different people save for different reasons. From saving for your retirement to having enough money for a down payment on your first home, it’s never too early, or too late, to get started.
People may use registered savings options like TFSAs and RRSPs differently, based on their personal situations. What’s important is to think about your own goals for the future. But thinking isn’t enough – be sure to follow through and book an appointment to speak with us about the type of option to help you achieve those goals.
Saving for Retirement
If you’re saving for retirement, then an RRSP may be a great choice. When you contribute into an RRSP, you defer paying tax from your peak earning years to retirement, when your income and tax liabilities may be lower. Think of it as a strategy that can optimize your saving capabilities.
While a TFSA is not specifically designed as a retirement savings account, its flexibility potentially can make it an excellent complement to an RRSP. If you have already maximized your RRSP contributions, then a TFSA may be an option for you to save more money and get the benefits of tax-free growth and withdrawals.
Look at the different scenarios below. Both Albert and Golnoosh are saving for their retirement, but they have different strategies.
Scenario 1: Saving for Retirement with an RRSP
Albert – 45 years old, mechanical engineer
Albert is saving for his retirement. His income is high now, but he expects to earn less once he retires. His goal is to retire by the age of 65 and spend more time with his family.
Why an RRSP?
An RRSP may be the most appropriate option for Albert because he is in a higher tax bracket. By contributing to a RRSP, Albert would pay less tax as it would help lower his taxable income now when his tax rate is higher. Albert would defer paying tax on his RRSP contributions until retirement when his income and tax liabilities may be lower.
Scenario 2: Saving for Retirement with a TFSA
Anita – 45 years old, mechanical engineer
Anita is saving to retire at the age of 65 and spend time with her family. She started her own company and makes a modest income but expects it to grow significantly.
Why a TFSA?
A TFSA may be the better option for Golnoosh because she expects to be making significantly more in the future than she does now. The TFSA may also provide the flexibility she needs because funds can be withdrawn tax-free at any time1 and any amount withdrawn is added back to her contribution room the next year.
Contributions to a TFSA are not tax – deductible and withdrawals from the account are not taxed.
With an RRSP, tax is deferred until the funds are withdrawn. So, in Golnoosh’s case, if she saves in an RRSP, she could end up paying more tax when she withdraws money in retirement than she normally would.
Will you have other sources of income?
It’s important to understand how your RRSP and TFSA can impact your eligibility for some federal income-tested benefits such as Old Age Security (OAS). The full OAS pension is available to those with incomes lower than $79,054 (2020), meaning that any income above this limit will reduce the amount of benefit you’re entitled to. For more information on public pensions visit the Government of Canada website.
How much can I save with a TFSA?
A TFSA means you won’t be taxed on any of the growth or income earned within the account. Which means your savings can grow even more.
Saving for a Home Down Payment
The Home Buyers’ Plan (HBP) is a program that allows first-time home buyers to withdraw up to a maximum of $35,000 from their RRSP towards buying their first home2.
If you’re saving for a new home, a good strategy can be to use the money from your RRSP to help pay for your down payment. The amount withdrawn can be paid back into the RRSP through instalments over a 15-year period.
Look at the different scenarios below. Both Samantha and John are saving for a down payment on a home, but they have different strategies.
Scenario 1: Saving for a Home Down Payment with an RRSP
Samantha – 28 years old, marketing associate
Samantha isn’t the best when it comes to her savings strategy and tends to pull money out to fund her everyday life. Her goal is to save enough for a down payment on her own home but she’s not confident she can do that while also saving for retirement.
Why an RRSP?
An RRSP would benefit Samantha because it will allow for the withdrawal of up to $35,000 for the purchase of her first home through the Home Buyers’ Plan without paying tax2. While saving for a home, she could also pay less tax by contributing to an RRSP because it would help lower her taxable income now when her tax rate is higher than it might be in retirement.
An RRSP might also help Samantha stay committed to her goal because she wouldn’t be able to make RRSP withdrawals for other expenses without tax implications.
Scenario 2: Saving for a Home Down Payment with a TFSA
John – 28 years old, marketing associate
John is dedicated to his savings strategy but lacks a rainy-day fund to access if he needs to. His goal is to save for a down payment on a home and, ultimately, he wants to save for retirement.
Why a TFSA?
John is saving for a home and retirement but also wants access to his funds, so he could benefit from having a TFSA. A TFSA allows him to make a withdrawal at any time1, for any reason, tax-free. Any amount withdrawn from a TFSA would be added back to his contribution room in future years, so he wouldn’t lose room in his TFSA.
What about the Lifelong Learning Plan (LLP)?
The Lifelong Learning Plan (LLP) allows you to withdraw amounts from your RRSP to finance eligible training or education for you, your spouse or your common-law partner2. You don’t have to include the withdrawn amounts in your income, and there is no withholding tax on these amounts. Withdrawals made must be repaid to the RRSP over a period of no more than 10 years, and unpaid amounts must be included in your income for the year they were due.
A TFSA can also help you to save for your education, but, withdrawals are treated differently; whereas LLP withdrawals must be paid back, there is no obligation to pay back TFSA withdrawals.
What about your income tax bracket?
The higher your income, the higher your personal tax bracket and the lower your income, the lower your personal tax bracket may be. If you’re in a low tax bracket, consider putting your money into a TFSA to help build up your capital. As you enter higher income brackets, you can withdraw your TFSA funds and make contributions into your RRSP to help lower your income taxes.