When it comes to saving for retirement, or even financial independence, you cannot afford to overlook the effect of tax on your portfolio. For people who have never invested (even on their own or with the support of a broker), understand the different type of accounts – along with acronyms and jargon that can feel daunting.
I understand your confusion well, so in this post, we’re going to demystify two of the most important ones: TSFA and RRSP in Canada.
While they both have tax advantages, there are key differences that you need to be aware of. If you want to be well prepared for your future and financial independence, you shouldn’t ignore these two tax-advantaged accounts and accidentally make mistakes.
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1. What are a TSFA account and RRSP account?
RRSPs have been a great option for Canadians to save and invest their money for retirement while delaying taxes since 1957. A tax deduction may be available to you if you contribute to an RRSP. This could help you pay less tax on your income in the year that you claim the deduction, which could help you save more money. Investment income and capital gains aren’t taxed as long as the money in the RRSP stays there. The money you take out of an RRSP is usually taxed, but there are some exceptions.
Since 2009, tax-free savings accounts (TFSAs) have given Canadians who are 18 or older and have a valid social insurance number (SIN) a chance to enjoy tax-free growth and income for the rest of their lives. You can’t get a tax break for giving money to a TFSA. As long as you follow the rules, the money you put in and the money you make from investments and capital gains in your account aren’t taxed when you take it out.
2. Key similarities and differences?
The key similarity of these 2 accounts are the tax advantages that you receive when contributing and the tax benefits you get when you take money out.
The main difference is how long the investment income and capital gains are tax deferred. In an RRSP, this benefit lasts until you retire, whereas in a TFSA it lasts forever. This means that if you think your income will be lower in retirement, an RRSP might be a better option for you.
Another difference is that you can’t contribute to a TFSA if your income is over $55,000, but there’s no limit to how much you can contribute to an RRSP. And finally, the biggest difference: how the money is taxed when you take it out. With an RRSP, you’ll likely pay less tax than if the money came out of a TFSA.
Each calendar year, you can contribute up to the TSFA dolar limit of the year, unused contribution room can be carried forward. The 2022 TSFA limit is $6,000.
For RRSP, the maximum contribution% of your earned income, to a yearly maximum of $29,210 for the 2022 tax year, or 18% of the prior year’s earned income, whichever is less. Unused contribution room can be carried forward. You can find your RRSP for this year by checking your CRA Tax notice of assessment after you file the tax, not before.
Why do you need to care?
You need to know the benefits and differences between these 2 accounts because tax can play a significant role in your financial planning. You might be investing or saving for retirement but it’s important that you’re aware of how different types of taxes affect what kind if return on investment as well as whether they’ll help protect against certain risks like losing eligibility due too much contributions made during ones’ golden years (age 50+).
TFSAs are better for people who are in a lower tax bracket or don’t expect to be in a higher tax bracket when they retire.
Which account is right for you?
It depends on your individual circumstances – like your income and when you plan to retire.
RRSP is more suitable for people who are expecting a higher tax bracket in the future, while TFSA is more suitable for people who are in a low tax bracket or do not expect to have a higher tax bracket when they retire.
Saving money and investing in TSFA is more suitable for financial goals in medium term : 3-5 years, while RRSP is more suitable in much longer term, or when you retire.
However the caveat is that, if when you retire, your annual income is higher than current (maybe you grow your networth and get high passive income, RRSP actually backfires. Withdrawing money from RRSP when you have higher tax braket in the future will hurt you more
Should you contribute to your TFSA or RRSP, or both?
Contributing to both an RRSP and TFSA is a good idea for most people. This will give you the best of both worlds: the tax deduction from your RRSP contributions and the tax-free growth and income from your TFSA contributions.
Just be sure that you don’t go over the annual contribution limit for each account. Otherwise, you will face a fine from CRA.
If you’re not sure whether you should contribute to an RRSP or TFSA, or if you’re wondering if you should contribute more to one or the other, speak to a financial advisor. They can help you figure out what’s best for your individual situation.
Mistakes people make with their TFSA & RRSP
TSFA mistakes
Here are the common mistakes that people tend to make mostly because of their own misunderstanding or ignorance :
– Overcontribute to RRSP and TSFA
-Cash transfer/withdrawal from TSFA to other accounts
– Holding Foreign (U.S.) Dividend Stocks
-Actively trade on TSFA account (active trading)
RRSP mistakes
– Withdrawing from their RRSP before retirement
– Overcontribute to RRSP
– Not contributing the maximum amount to their RRSP or TFSA
– Not Maximizing Employer RRSP Matching Contributions
FAQ
-Who is eligible to open these two accounts?
Any residents in Canada who work and pay tax in Canada are eligible to open RRSP and TSFA.
-Can I contribute to my spouse’s TFSA or RRSP account?
Yes, you can contribute to your spouse’s RRSP account, but you cannot contribute to their TFSA.
-What is the deadline for contributing to an RRSP or TFSA?
For RRSP, the deadline is March 01; and for TFSA, the deadline is December 31.
-Can I withdraw money from my RRSP or TFSA whenever I want?
Yes, you can withdraw money from your RRSP or TFSA whenever you want, but you will have to pay tax on the withdrawal
-Can I contribute to both an RRSP and a TFSA in the same year?
Yes, you can contribute to both an RRSP and a TFSA in the same year, but you can’t contribute more than the annual contribution limit for each account.
-What happens if I go over the annual contribution limit for my RRSP or TFSA?
If you go over the annual contribution limit for your RRSP or TFSA, you will face a fine from CRA.
-Can I use my RRSP to buy a house?
No, you can’t use your RRSP to buy a house. You can use it to buy a home, but you will have to pay back the money you took out of your RRSP within a set time frame.
-Can I use my TFSA to buy a house?
No, you can’t use your TFSA to buy a house. You can use it to buy a home, but you won’t get any tax breaks for doing so.
-Can I contribute to my spouse’s RRSP or TFSA?
Yes, you can contribute to your spouse’s RRSP or TFSA, but you will need to have their consent.
-What happens when I die?
When you die, the money in your RRSP and TFSA will go to your estate. It will be taxed as income in the year it’s received.
-Can I use my TFSA to pay for my kids’ education?
No, you can’t use your TFSA to pay for your kids’ education. You can use it to save for their education, but the money will be taxed when you take it out
Final thoughts
RRSP and TSFA are two very important investment accounts for Canadians. However, many people still confuse them or make mistakes with them because they don’t understand how they work. In this blog post, I have outlined the similarities and key differences between RRSP and TSFA, as well as the most common mistakes people make with these accounts. I hope this information was helpful and informative. If you have any questions, please don’t hesitate to ask a financial advisor.
Now it’s time to take action! Talk to your partner and decide which account is right for you. Then start contributing today so you can start reaping the benefits of tax savings and investment growth.
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Disclaimer: Please note that the information in the blog post is for educational purposes only and the information can be changed anytime. Make sure to check the latest information on the government websites. I am not a financial planner and would not be responsible for any of your decision made from the information from this blog. Read our Disclosure here
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Minh
Minh is a personal finance enthusiast, a CFA charter holder, and a Strategy consultant by profession. She loves to talk about everything personal finance-related. She wants people who read her blog posts to feel empowered and inspired in their journey to master their finances and towards financial independence, just like herself.
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