Canadian Registered Retirement Savings Plans vs. Tax-Free Savings Accounts
Registered Retirement Savings Plans
Registered Retirement Savings Plans (RRSPs) are retirement accounts registered with the Canadian government. RRSPs are tax-deferred accounts, meaning that taxes are deferred for contributions made to or earnings gleaned from the accounts for the period in which they are held. Taxes are paid when money is withdrawn from the account. Any Canadian can open an RRSP account, and there is no age limit to starting one prior to the age of 71 (see below). In fact, any Canadian who has a job and pays taxes can open an RRSP account in their name and have the benefit of making tax-deductible contributions.
Tax-Free Savings Accounts
Like RRSPs, tax-free savings accounts (TFSAs) are registered with the Canadian government and are used for saving money. No tax is paid on the interest or investment income gained from the money placed in a TFSA. Money can be withdrawn from a TFSA at any time, and there are no limits on what the money can be spent on. However, if your main objective is to prepare for retirement, you will likely want to leave the money in the TFSA so you can earn tax-free funds from the savings and returns on investments.
What’s Different and What’s the Same?1
- While they may both be used for retirement, only the RRSP is explicitly intended for that purpose.
- TFSAs are only open to Canadians over the age of 18. RRSPs only require you to be paying taxes and earning an income (not necessarily through employment).
- Contribution limits for an RRSP include a limit of 18% of your earned income for the prior year (a maximum is set each year), as well as any unused contributions from previous years.
- Contribution limits for a TFSA change periodically. In 2021, the contribution limit was $6,000, along with any unused contributions from prior years.
- Unused contributions refer to any years in which you did not contribute the maximum amount. That unused contribution amount carries forward. This is true for both RRSPs and TFSAs.
Withdrawals work differently when it comes to contribution limits.1
- Since you can withdraw from a TFSA at any time, the contribution room comes back the next year.
- In contrast, you lose the contribution room with an RRSP. For this reason alone, not to mention the potential for growth you would lose, it’s best to avoid withdrawing from RRSPs unless it is planned and necessary.
While both accounts have advantages where taxes are concerned, they have different rules.1
- RRSPs are not only tax-deferred, but also tax-deductible. This means you reduce the amount of tax you pay in the years that you contribute.
- TFSAs are not tax-deductible, but withdrawals are tax-free. (Withdrawals from an RRSP are taxable at your annual marginal tax rate, which is not as advantageous for day-to-day withdrawals.)
You Don’t Have to Choose.
There are many advantages to using both an RRSP and a TFSA when it comes to your retirement strategy. Both are versatile and have aspects that will prove handy, both today and in the future.
The cutoff time for contributing to your RRSP is the last day of your 71st birthday year. At that point, the RRSP is converted into a registered Retirement Income Fund, that pays out in an annuity or one-time lump sum. TFSAs don’t have that sort of cutoff, and you can continue to use them throughout your retirement.1
This content is developed from sources believed to be providing accurate information, and provided by Twenty Over Ten. It may not be used for the purpose of avoiding any federal tax penalties. Please consult legal or tax professionals for specific information regarding your individual situation. The opinions expressed and material provided are for general information, and should not be considered a solicitation for the purchase or sale of any security.