Most people have heard the acronyms TFSA and RRSP and know they stand for Tax Free Savings Account and Registered Retirement Savings Plan but a lot of the rest is a mystery to most.
It’s easy to think “Hmm tax free: that sounds good to me!” Of course you may also be thinking “but retirement, and saving, I should be doing that as well.” Luckily both are savings vehicles that can benefit you in different ways. The best way to make a decision is to know which type of account works in your best interest (pun intended).
Hmm tax free: that sounds good to me!
The tax free savings account is just as it sounds: you contribute money that you have already paid taxes on and growth within the account is considered tax-free. When you withdraw the funds the idea is that you can withdraw them tax-free.
TFSAs have a lifetime limit on the amount of funds you can contribute and a yearly limit, that can change year to year. As of right now the max amount you can contribute to your TFSA is $57,500.00 but this must be done by following the maximum contribution room you have available each year. The government has the ability to change the max amount you can contribute to your TFSA and the maximum yearly contribution you can make. Currently you can contribute $5,500.00 a year to your TFSA. Once you have reached a contribution of $57,500.00 over the years to your TFSA you have maxed out your TFSA.
Below is a chart that may help you better understand the changes in yearly and maximum contribution room:
|Years||TFSA Annual Limit||Cumulative Total|
Retirement, and saving, I should be doing that as well
An RRSP (or RSP) is another savings vehicle that has tax benefits, just different ones from a TFSA. One of the great features of an RRSP is that any amount contributed can be written off against your current income (meaning you have the pay that much less in taxes at the end of the year). So if you contribute $5000 to your RRSP, (your income actually reduces, therefore, you owe less tax), eg 40% tax bracket you would get back $2000. There is a limit as to how much can be contributed in year.
The current RRSP contribution limit for 2017 is 18% of earned income you reported on your tax return in the previous year, up to a maximum of $26,010. If you have a company pension plan, your RRSP contribution limit is reduced.
Another perk of an RRSP is that the growth on an RRSP is tax deferred (not tax-free). In other words, any profits made on investments within an RRSP account in the form of interest, dividends or capital gains are not immediately taxable to you as income. Tax deferral remains a benefit because, in theory, income tends to be lower in retirement than in your peak earning years. Therefore, you’re reducing your tax bill now by writing contributions off against your current income and by paying the taxes later when your income and tax bracket will most likely be lower.
They Do have Similarities
Generally, the types of investments that are permitted in a TFSA are the same as those permitted in an RRSP. This would include:
- Mutual Funds
- Segregated Funds
- Securities listed on a designated stock exchange
- Guaranteed investment certificates
- Certain shares of small business corporations
So what’s the difference?
The tax treatment of a TFSA is the opposite of a RRSP. There is an income tax deduction for contributions to an RRSP, and withdrawals of contributions and investment income are all taxable. In contrast, there is no tax deduction for contributions to a TFSA, and there is no tax on withdrawals of investment income or contributions from the account.
Unlike an RRSP, which must be withdrawn before the holder turns 71, the TFSA does not expire.
If an account-holder withdraws funds from a TFSA, his or her contribution room is increased by that amount on the 1st of January after the withdrawal. In an RRSP, the contribution room is not increased to reflect withdrawals.
The Canada Revenue Agency (CRA) describes the difference between a TFSA and an RRSP as follows: “An RRSP is primarily intended for retirement. The TFSA is like an RRSP for everything else in your life.”
As you can see, there are many scenarios that will make either a TFSA or RRSP work best for you. Some people suggest maxing out your TFSA before contributing to your RRSP but each situation in life can call for a different course of action. Speak with one of our advisors today to find out which choice works best for you and your life.
**Advisors and staff at Davlyn Financial Services Inc. are not tax experts. Please consult an accountant for all tax related matters. Investments are sold through prospectus only. This is for information purposed. Consult a financial advisors for Details. E and O, E”**