Investing in tax-deferred options is one of the most prudent ways of saving for the future and building a reliable retirement fund in Canada. Both, Registered Retirement Savings Plans (RRSPs) and Tax-Free Savings Accounts (TFSAs) offer tax-advantaged opportunities that can help you achieve your savings and investing goals. However, since they work in different ways, it’s important to understand when to use one versus the other, or both in tandem.
Different Between TFSA and RRSP
As a general rule of thumb, RRSPs are better suited for individuals with higher income levels. If you fall under this category and are looking to build a fund for your retirement, first home, or education, contributing to an RRSP plan can work to your advantage due to no upfront taxes. TFSAs are more flexible and highly suitable for short-term savings goals, such as a vacation or home renovation.
Here are the key differences between RRSP and TFSA:
- Age Restrictions: You can contribute to RRSP plans until December 31 of the year you turn 71. Anyone with earned income and a filed tax return can open an RRSP account. Many companies offer employees the option to enrol in their group RRSP plans, where the employer matches your contribution and enables direct deduction of your contribution through your paycheck. For TFSA, the minimum age is 18 years. Anyone 18 and over can open a TFSA account.
- Contribution Limit: For RRSPs, you can contribute 18% of your last earned income, up to a maximum limit set each year by the CRA. The 2021 RRSP contribution limit was $27,830. For TFSA too, the limit changes periodically and currently stands at $6,000. Both types of accounts allow you to carry forward the unused contribution limit into subsequent years and charge identical penalties of 1% per month on the excess amount in the event of overcontribution. The $2,000 buffer (over your lifetime) for overcontribution is also applicable for both accounts. In addition to your own RRSP account, you can make RRSP contributions to your spouse’s or common law partner’s account. This option is not available for TFSAs.
- Tax Advantages: With RRSP contributions, your money grows tax-free and your contributions are tax-deductible. You pay taxes at the time of withdrawal. In the case of TFSA, your money grows tax-free and you pay no tax on withdrawals either. However, your contributions to TFSA are not tax-deductible.
- Withdrawal Conditions: You can withdraw from your RRSP account at any time and for any purpose. You will pay tax on the withdrawn amount as per your marginal tax rate for that year. However, you may get tax exemptions if you use the withdrawn amount towards the Home Buyers Plan (HBP) or Lifelong Learning Plan (LLP). TFSA accounts allow tax-free withdrawals at any time, and for any purpose. Your contribution room is adjusted and added back to the subsequent year.
What is your Savings Goal?
Since both plans offer tax-sheltered investment growth, you can consider opening a TFSA account, as well as an RRSP account. If you have the financial means to maximize your allowable contribution limit to both accounts every year, you are likely to reach your savings goals much faster than relying only on one type of account. However, if it is not possible for you to invest in both accounts, then let your savings goals guide your decision. Use RRSPs for building retirement funds, and use TFSA for shorter term goals, such as buying a car, renovating your home, starting a business, building an emergency fund, taking a vacation, and so on.
Let Wealth Management Experts Guide Your Investment Plans
At Nour Private Wealth (NPW) , our competent and experienced wealth advisors offer a range of investment planning services. We ensure a diversified portfolio that takes into consideration your income, risk appetite and financial goals. Take advantage of our knowledgeable team, carefully curated investment plans, and personalized services today.
Need help in maximizing your contribution through RRSPs, TFSAs or both? Get in touch with an NPW Wealth Advisor by calling 1-855-545-9090.