RRSP vs. TFSA: Which Should You Choose
Written by: Jamie White, Staff Accountant at Sone Rovet Chasson LLP
July 18, 2017
“The earlier you start saving for the retirement, the better.” I am sure you have heard this or something similar when watching bank commercials espousing this basic principal every February during RRSP (Registered Retirement Savings Plan) selling season. I know I certainly have, and although it can be true, in most cases it’s not that simple. There could be many reasons why someone may not be able to save the way they want, but the most common question from my friends and family is “Should I contribute to an RRSP or a TFSA (Tax Free Savings Account)?”
Both options allow the contents of the account (investments, cash, etc.) to grow and save you tax dollars. However, this is where the similarities between the two options end.
Any contribution you make to an RRSP can be deducted from your taxable income in the year the contribution is made, which means you are using before tax dollars. Instead you are taxed when you withdraw the funds out of the account, usually when you retire and are in a lower income tax bracket. In addition, any income earned within the RRSP is sheltered from income tax until it is withdrawn from the RRSP. The RRSP is typically beneficial when you are anticipating a decrease in income when you retire. The idea is that you contribute to your RRSP when you are in a higher tax bracket, and withdraw it when you are in a lower tax bracket, saving you tax overall during your lifetime.
You are also able to withdraw the funds without a penalty to make a down payment of up to $25,000 on your first home (HBP) or up to $20,000 to finance full time post-secondary education or training (LLP) The balance must be paid back in equal payments over 15 years for the HBP and 10 years for the LLP. Otherwise, your minimum annual repayment will be added to your taxable income in the year you miss a repayment and you will have to pay the tax on it.
The amount you are allowed to contribute to your RRSP is limited to 18% of your earned income from the previous year (up to a maximum contribution of $26,010 for 2017). If you end up not contributing up to your allowed limit, the unused contribution room gets carried forward so you can take advantage of it in future years, if you so choose.
On the flip side, the TFSA operates in a much different way. Any contribution to a TFSA is not tax deductible and therefore is made with after tax dollars. As a result, when the funds are ultimately withdrawn from the account, they are not subject to income tax. In addition, any income earned within the plan is also never subject to income tax. Unlike the RRSP, the TFSA is more flexible in that you can withdraw the money without having to worry about any income tax consequences.
The TFSA is typically more beneficial when you are expecting to have the same or higher income in retirement, because the money you withdraw from it is not included as part of your taxable income. The amount you are allowed to contribute to your TFSA for 2017 is $5,500, but, like the RRSP, any unused room carries forward and can be used in the future (if you haven’t contributed at all to a TFSA since 2009, then you may be able to contribute up to $52,000 by the end of 2017). It should be noted that any withdrawals made during a specific year will only be added back to your available contribution room in the following calendar year.
The name Tax Free Savings Account can also be a bit misleading. You can hold a number of different types of investments in the account including GIC’s, stocks, bonds and mutual funds among other common investments.
Just remember that that every individual case is unique. If you are ever in need of assistance with this or any other tax issue, please do not hesitate to contact us here at SRC LLP and we would be happy to assist you!