RRSP vs. TFSA

Take Aways:

TFSA and RRSP

1: Overview and Purpose

• TFSA (Tax-Free Savings Account)
  • Definition and basic features.
  • Investment options similar to traditional financial products.
  • Benefits include tax-free growth and withdrawals.
• RRSP (Registered Retirement Savings Plan)
  • Definition and intent for retirement savings.
  • Allows investments like bonds, stocks, and ETFs.
  • Tax implications including deductions and deferred taxes.

2: Investment Considerations

• Contribution Limits and Conditions
  • RRSP contributions are based on income, with tax-deductible benefits reducing taxable income.
  • TFSA contributions do not affect taxable income but have an annual limit, offering more flexibility with withdrawals.
• Strategic Use
  • RRSPs are ideal for high-income earners who anticipate lower income after retirement.
  • TFSAs suit lower income earners or those needing flexible withdrawal options without tax penalties.

3: Tax Implications

• RRSP Withdrawals
  • Taxed as ordinary income.
  • Potential high tax rate on withdrawal depending on income level.
• TFSA Withdrawals
  • Not subject to taxes, providing significant benefit in flexible financial planning.

4: Planning for Retirement and Other Goals

• Long-term vs. Mid-term Goals
  • RRSPs typically for long-term retirement savings; however, can be used for mid-term goals like home purchases via the Home Buyers Plan.
  • TFSAs offer flexibility for both retirement savings and other financial goals without impacting social benefits or incurring taxes.
• Impact on Government Benefits
  • RRSP withdrawals could affect eligibility for certain government benefits due to increased taxable income.
  • TFSA withdrawals do not affect government benefit eligibility.

5: Real-life Application and Strategy

• Financial Strategy
  • Importance of strategic planning when contributing and withdrawing from these accounts to maximize benefits.
  • Examples of planning for different income scenarios and life stages.
• Advice and Recommendations
  • Encouragement to use both accounts strategically based on personal financial situations.
  • Suggestion to consult financial planners for personalized advice.

Conclusion

• Emphasizes the need for strategic use of both TFSA and RRSP based on individual circumstances and future income predictions.
• Recommends continued education and discussion with professionals to optimize personal financial planning.

SUMMARY

Understanding TFSA and RRSP: A Guide for Beginners

When it comes to saving money, especially for the future like retirement, Canadians have two main options: the Tax-Free Savings Account (TFSA) and the Registered Retirement Savings Plan (RRSP). Each has its unique features and benefits, and choosing between them can seem complicated. This blog will help you understand what TFSAs and RRSPs are, how they differ, and how to use them wisely.

What is a TFSA?

A TFSA is a type of savings account that allows you to save money without paying taxes on the interest or earnings from your investments. You can put money into a variety of investments like bonds, stocks, and ETFs (Exchange-Traded Funds) through any financial institution. The key benefit of a TFSA is that you don’t pay taxes on the money you make from these investments, and you don’t pay taxes when you take the money out.

What is an RRSP?

An RRSP is designed specifically for saving for retirement. Like a TFSA, you can invest in bonds, stocks, and ETFs. However, the main advantage of an RRSP is that the money you contribute is deducted from your income. This means if you earn $100,000 a year and you put $20,000 into your RRSP, you only pay taxes as if you earned $80,000. This can also lead to a tax refund because you paid taxes on a higher income than what you’re declared after the RRSP contribution.

Key Differences and Considerations

Investment Limits

Both TFSAs and RRSPs have limits on how much money you can contribute each year. For TFSAs, the limit isn’t based on your income, but it has a set maximum each year that increases over time. For RRSPs, you can contribute up to 18% of your income, up to a maximum that changes each year.

Tax Implications

The biggest difference between a TFSA and an RRSP is how they handle taxes:

• RRSPs: You don’t pay taxes on the money you put in now, but you will pay taxes later when you take the money out during retirement. This is beneficial if you will be in a lower tax bracket after you retire.
• TFSAs: There are no tax benefits when you put the money in, but you also don’t pay taxes on the earnings or when you take the money out. This is great for flexibility, as it doesn’t impact your tax situation regardless of how much you withdraw.

Using Them Wisely

• For Retirement: RRSPs are particularly beneficial for those who are currently in a high tax bracket because they get to reduce their taxable income now and pay taxes later at a potentially lower rate. TFSAs are great for people who might not benefit as much from tax deductions now or who expect to be in a similar or higher tax bracket in the future.
• For Other Goals: RRSPs can also be used for short-term goals through specific plans like the Home Buyers’ Plan, which allows you to borrow money from your RRSP to buy your first home. TFSAs are more flexible, allowing you to save for any goal, such as buying a car or a house, without worrying about taxes.

Conclusion

Both TFSAs and RRSPs are powerful tools for saving money, each with its own benefits depending on your financial situation and goals. It’s important to think about how much money you make now, what your taxes will look like in the future, and what you’re saving for. If you’re not sure which is best for you, it might be a good idea to talk to a certified financial PLANNER who can provide personalized advice based on your specific circumstances.

TRANSCRIPT

TFSA versus RRSP. This is probably one of the most popular questions I get from clients: Should I be contributing to my TFSA or should I be contributing to my RRSP? Today, we’re going to go over that, but before we do, we’re going to lay some foundation. We’re going to talk about what exactly a TFSA is, what exactly an RRSP is, and then from there, we’re going to go into the differences and discuss under what circumstances you would invest in each.

So, let’s start off with an RRSP. An RRSP is a registered retirement savings plan that’s meant for saving for retirement, as the name suggests. And essentially, what can you invest in an RRSP? You can invest in bonds, stocks, ETFs—your typical investment stuff that you get off the shelf if you go to any traditional financial institution. You could also invest in other things outside of that, but let’s just keep it simple for now. All the things available at a traditional financial institution you could put in an RRSP. Right. The next thing is the tax deduction. That is one of the strong benefits of an RRSP. The thing is, when you contribute to the RRSP, it lowers your income. So, if you make, for example, a hundred thousand dollars this year, and you contribute $20,000, your income drops from a hundred thousand to 80,000 because the $20,000 you contributed to the RRSP is treated as a tax deduction. Right. And in circumstances like that, what may be provided is some type of a tax refund because the government looks at your situation and says, “Well, we taxed you at $100,000, but effectively, your income for the year is $80,000.” Now, once money goes into an RRSP, it is tax-deferred, which means while it’s sitting in that RRSP, you do not pay taxes. So generally, at a high level, that’s an RRSP. Now let’s talk about a TFSA. A TFSA is a tax-free savings account.

Now you could save again the traditional investment products, bonds, stocks, ETFs that you’d probably get from off the shelf at any traditional financial institution. You could take that, you could invest that in a TFSA. Now when you contribute, you do not get a tax deduction, but a benefit is it not only grows tax-free, but when you’ve pulled the money out, it is also treated as such, meaning you’re not taxed when you pull the money out. And that’s why a lot of people love the TFSA.

A lot of people may have certain challenges or certain reservations about RRSPs because their concern is that they’re going to be pulling money from an RRSP and it’s going to be taxed at some point. Right? And we’re going to talk about that and when you should consider an RRSP and not. Right? Okay. Now, how old do you need to be to contribute to an RRSP? There’s no actual age limit. I know a lot of people believe that you have to be 18 years old.

But quite frankly, you just need to earn employment income and business income to have that room. And if you have the room, you can contribute. So if you’re 16 years old and you’re making decent money and you’re making sufficient money to get the room, then quite frankly, you can start contributing to an RRSP. With a TFSA though, it’s a little bit different. You must be at least 18 years old and a Canadian resident to contribute to a TFSA. Now, how much can you put in?

For an RRSP, you could contribute up to 18% of your earnings from last year. And for 2024, that amount is maxed out at $31,560. But not only do you have this year’s room, but you have room from previous years if you haven’t used it. So essentially, it’s this year’s room, 18% of your earnings from last year, but it’s maxed out at $31,560, plus additional room. Now for the TFSA,

Annually, you have a certain amount of room that’s granted to you. For 2024, that amount is $7,000. The total amount is $95,000 if you have been a permanent resident and over 18 since 2009. Right. And that amount, it changes over the years. One year it actually decreased, but in most instances, the contribution will increase. So that’s how much you could put in for the RRSP.

That’s how much you could put in for the TFSA. Now, what if you pull money out? Now, if you pull money out, you have lost that room if it’s an RRSP. So if you have, say,$50,000 room and you’ve maxed out that room and you pull $10,000 out, you only have $40,000 left in there. That’s the room you have. You cannot get that $10,000 back; you’ve lost it. The TFSA is different, though. If you have, say for example, $90,000 and you pull out $20,000 to buy a car, and this is the year that you pull the money out—so it’s 2024—you pull $20,000 out to buy a car, you get your bonus of $20,000 that you want to put in, but you’ve maxed out your TFSA for this year, you’re not going to be allowed to put that money in without some type of penalty until next year. So you have to wait until the following year, and once you have the following year, that amount is added back into your room.

So that’s a big difference there. You have to think twice if you’re pulling from your RRSP, because once you’ve pulled, you’ve lost that contribution. Whereas with a TFSA, there’s some flexibility there. You say, okay, you pulled this year if you need to, but you know you get a room back and you can go back and contribute again. Now, do you pay taxes if you pull money from the RRSP? Yes, you pay taxes. And it’s treated as ordinary income, which is typically the highest level of taxes that you’re going to pay. But at least the potential for it is the highest—53.53% as of today where we speak. Now when you pull money from a TFSA, there are no taxes there. Again, we said that a few times, but it’s worth mentioning. Okay, how much you make now and what you think you’ll make in retirement is a huge part to consider when you’re contributing to a TFSA. Let’s talk about how much you make now and then we’ll talk about retirement. If you are making, say, $50,000 or more,

It’s worth looking at an RRSP because of the amount you contribute. There’s a tax deduction element to that. And you know, you’ll save on taxes. The perfect reason to use an RRSP is for you to contribute when you’re at a higher level of income and to pull money out when you’re at a lower level of income. So for example, if you’re making over $200,000 and you contribute to an RRSP, and this is money, you know, you’re making over $250,000.This is money that would essentially be taxed at 53.53%, right? But you have structured and have a plan in place such that when you go to pull the money out, you’re at a much lower income bracket, which would be essential for an RRSP. And that’s one of the benefits of an RRSP. It makes no sense, for example, if you contribute when you’re at $50,000 and at your retirement, you’re at $70,000 because you earned it when you would have paid.

Lower—you don’t pay at a lower tax rate. I know you pull it when you’re paying at a higher tax rate. Granted, you get the benefit of a tax deferral, but it’s not as effective as if you would have contributed when you’re at a higher income rate and then pull it out when you’re at a lower income rate—that is where a lot of people have challenges with RRSPs. And that is where the planning aspect of it comes into play because what you want to do is structure your financial plan in such a way that you contribute to when you’re at a higher level and you withdraw when you’re at a lower level. If you haven’t done that, in some instances, it could actually be counterproductive. So that’s the thing to consider with an RRSP. Now, if you make less than $50,000, there’s no real tax deduction there. And even if you have the room, it may not make sense to contribute to an RRSP. And so a TFSA makes absolute sense. Right? 

So,That’s usually my consideration. Now, let’s speak to retirement as it relates to TFSAs. TFSAs are great for retirement planning because it gives you that flexibility to prevent clawbacks. It gives you the flexibility to not be hit with penalties if you’re getting certain government benefits.

And so, and quite frankly, what you’re able to do is look at a certain amount that you want for that particular year. And you could use the TFSA as that buffer that puts you below certain thresholds. So you’re not taxed as much. And as we mentioned before, and so certain government benefits that you have coming your way are not taken away because of those income thresholds. The TFSA allows for that flexibility. And here’s a beautiful thing, because you could, you know, continue contributing in the following years. What you could do is you could use up the room for the TFSA, get the room back next year, and then move different accounts, maybe like a non-registered account or savings accounts or whatever it is, depending on your circumstances, and fill up that gap that you have in a TFSA that continues to grow tax-free and gives you the opportunity to pull out tax-free. 

So just so you know, that is where a lot of the conversation usually lands for me and my clients. So again, I’ll talk about this high level, because this is where a lot of people have the concerns. You contribute to a TFSA when you’re at your highest earning potential, maybe not the highest, but a higher income potential. And what you want to do is withdraw from the TFSA when you’re in a lower income potential. TFSAs are great if you are not making that $50,000 and you’re below the threshold.

Absolutely, you’re going to contribute to a TFSA and a TFSA is also great for retirement because of the loans for flexibility. So you don’t get hit with things like OAS clawbacks or you don’t lose certain government benefits or just for retirement planning generally. Because what you’re able to do is essentially what I’ve done with my clients. Look at the December or look at the top of the year and we go, “This is how much you will need based on your spending last year, based on inflation,” and we can be strict about exactly how much money comes out. We look at CPP, we look at OAS, we look at non-regs, we look at all the different vehicles available to us, and we can literally plan what the taxes will be for this year. Now, things may happen, you know, inflation may happen, and maybe a year you go, “Well, our expenses are much higher than we thought,” and we make changes, right? But it at least gives us that flexibility to still control our taxes, and it’s huge for a time.

I don’t want to talk too much about this because I think I kind of hammered it home. But again, the flexibility of a TFSA is huge because when you pull from a TFSA there are no taxes and it just shields you from a lot of penalties, a lot of taxes, and a lot of benefits that you would have gotten, you may have lost if you pull it from something like an RRSP that’s going to be treated as ordinary income that increases your income. And so, you probably will not be qualified for certain things. So that TFSA flexibility is really unparalleled. I mean, it’s a great vehicle. I think it’s amazing. The only, my only downside is, you know, the TFSA doesn’t have enough room. And slowly of course, it increases year by year. Okay, so what are you saving for? When you think about RRSPs and TFSAs, that’s an important thing because, For RRSPs, for most circumstances, you’re thinking long-term retirement. Now, the one exception that I will highlight is, for example, using your RRSP for a home buyers plan. A home buyers plan, depending on where you are now, could be like a midterm goal. I call it a midterm goal, you know, five years, ten years ago. And you may look at an RRSP, okay, let me keep contributing to this RRSP, and at some point in the next five years, three years, ten years, seven years, wherever you are, I will be pulling from that to purchase a home. So even though the vehicle is for long term, I always say, you’re going to take a pit stop. And so for a midterm goal, I think, you know, RRSP, a home buyers plan is a great opportunity. Now it’s been increased from $35,000 to $60,000 starting April 16, 2024. And that money has to be contributed back. So if you take $60,000 over the next 15 years, you have to contribute that $60,000 back over the 15 years. Otherwise, it’s going to be treated as income. 

Alright. So, you know, this is where even though we have the RRSP for long-term goals, there may be an opportunity to plan midterm there. For other situations, like a car, you know, certain appliances, you know, things that you want to do, which are larger items. I think the TFSA,

is a great opportunity, is a great vehicle to look at. I may provide you with the feasibility to do that. That being said, I will also stress that with a TFSA, I think it’s super, super, super important to consider using it also for long-term planning, just because you have the opportunity to pull that money out tax-free. And one more thing I will addby the way, when you pull from the homebuyers plan, it’s not treated as income unlike any other circumstances. So between a homebuyers plan and pulling money for education, if you’re at a qualified institution, there are some exceptions there. But that being said, I don’t know those two exceptions. When you pull from an RRSP, you’re going to get taxed. Now, choosing between both. I’ve said a lot. Simply put, if you’re just starting out and you’re not making a lot of money and you’re below $50,000, quite frankly, the TFSA is probably going to be the best bet. Once you start earning more income, the RRSP is going to be something you look towards. However, you have to be strategic in that you have to plan when you’re taking that money out. And essentially what you want to do when you contribute to an RRSP is contribute when you’re at your higher income potential and

hold that money out at a later date when you’re in a lower income bracket. In fact, there may be circumstances before you retire where you’re in a lower income, maybe you’ve taken time off work, maybe you’ve been let go, whatever the circumstances are, where it may make sense to pull from your RRSP because you are at a lower income and transfer it over to a TFSA, which continues to grow tax-free.

And when you pull that money out, it is tax-free. So while there are a lot of moving parts here, planning for RRSP and TFSA makes the most sense within a plan. And that’s why you don’t just take money and throw it in each account because it’s empty or because you want it to match up. You should have some plan around this. You should have some strategy around it. And it should fit in your overall goal and your values. If not, even though you may reap some of the benefits, for example, you may contribute to an RRSP, get a tax deduction, get a tax refund. However, if you’re not strategic when you go for retirement, you may even be in a higher income bracket, which yes, you’ve got the benefit of a tax deferral, but now, you’re still paying more taxes than if you were more strategic.

you could have paid much lower tax. And quite frankly, the biggest challenge, especially in retirement, is that you have so many things to pull from. 

Usually, most individuals, while they’re working, have one income source, maybe two. Unless you’re a business owner, you have all these different streams of income. And then you get to retirement, you have CPP, you have OAS, you probably have a private pension, you have RRSP, you have a TFSA, you have a non-reg, and you have a savings account.

And you’re going, six, seven different things. What should I pull from? I know how much money I want. If you’re not strategic about that, you could be losing a lot of money. Right. And so hopefully, this kind of brought some clarity to the situation. And by the way, I know I phrased it as an RRSP versus TFSA. You know, quite frankly, they’re both meant to be worked with, you know, work side by side because many people use them and get the best of each. And quite frankly, that’s how you want to use it. Depending on your circumstances, you pull out that tool, whether it be the RRSP or the TFSA or maybe just the TFSA, maybe just the RRSPs. It depends on your circumstances. But again, I hope I was able to bring some clarity to this. Have a wonderful week. Next week, I’ll also choose a topic, usually based on conversations I have with a client. And I’ll come here, talk for eight to 10 minutes and then I’ll sign off. Have a wonderful week. If you found this information helpful, like, share, subscribe. Thank you.