Since Tax-Free Savings Accounts (TFSA) where introduced in 2009, the debate between which vehicle should be used for retirement savings has intensified. Especially as life time contribution limits for TFSA’s have become larger. Registered Retirement Savings Plans (RRSP) were, and still are, an important part of any long term savings strategy, as it provides tax free growth on assets.
RRSP’s are specifically designed for retirement savings (it is in the name). There are a few other ways you can use them, as a first time home buyer or for certain types of continuing education, but its essential purpose it is to save money to live off when you are done working.
You can claim a deduction on your income tax return for RRSP contributions up to 18% of your “earned income” for the prior year to a maximum of $27,830 for 2021 ($27,230 for 2020), minus any pension adjustment, plus any unused contribution room from prior years.
You can access your RRSP funds if needed at anytime, but any money that you withdraw will have withholding taxed applied immediately, from 10% to 30% depending on the amount. Plus the proceeds will be added to your annual income, so you could owe more at years end. One of the downfalls of withdrawing funds early is that you lose that contribution room, and you do not get it back.
Where as an RRSP is really designed for retirement savings, a TFSA has the flexibility to be used for a number of different savings goals. Any Canadian resident who is at least 18 years old is permitted to open a TFSA, provided they have a social insurance number. The amount you can contribute to a TFSA is based on your “TFSA contribution room.”
Starting in 2009, each Canadian resident who was aged 18, automatically began to accumulate TFSA contribution room annually. This TFSA contribution room is cumulative and unused room is carried forward indefinitely to future years. Canadians who were at least 18 in 2009 and, as of 2021, and have not yet opened up a TFSA could immediately contribute $69,500.
The most significant difference between a TFSA and RRSP, is that any amounts withdrawn from a TFSA in a particular year will be automatically added to your TFSA contribution room for the following year. The second most significant difference is that TFSA contributions are after tax or “pre paid” contributions. This means no income tax deductions and no refunds.
The true advantage of the TFSA is its flexibility. It can not only compliment a retirement savings plan, but could also be used to compliment an educations savings plan, saving to buy a vacation property or, simply as a emergency plan. We also see retires move money from their RRSP/RRIF into the TFSA as they draw down their registered accounts. It allows the income they may not need right away to continue growing tax free.
When it comes to the debate of RRSP versus TFSA there is no need to choose one, you can use them both. By working with your Advisor you can develop a financial plan that helps determine the best way to utilize these accounts and find the best strategies for your investment philosophy.
-The CM Group