Saving and investing should not be complicated. In fact, it is a good financial practice to save and invest for financial goals and retirement purposes. You can save and invest using either a registered retirement savings plan (RRSP) or a tax- free savings account (TFSA). It may even be beneficial to use both savings plans. Before you decide which savings plan to use, it is essential to know the basics of both accounts and what benefits they provide.
The Tax-Free Savings Account
The TFSA is a savings account you can use to invest and grow your money tax- free. It is no wonder Canadians opt to start investing using the TFSA. You can use the money in your TFSA for any financial goal, such as buying a house, paying for education, purchasing a car, or even traveling.
Generally, you contribute after-tax income to a TFSA, and there is no tax deduction for your contributions. The Canada Revenue Agency (CRA) sets an annual contribution limit. For 2022, the TFSA contribution limit is $6,000.
Since the CRA introduced the TFSA in 2019, the historical contribution limits have been as follows:
2009 to 2012 – $5,000
2013 and 2014 – $5,500
2015 – $10,000
2016 to 2018 – $5,500
2019 – $6,000
2020 – $6,000
2021 – $6,000
2022 – $6,000
Your unused TFSA contribution room accumulates for each year you are eligible to contribute. For example, if you were eligible to open a TFSA since 2009, and have not made any contributions, as of 2022 you can invest up to $81,500, which is your total unused contribution limit from 2009 to 2022.
You can open a TFSA when you turn 18 (19 years in some provinces).
To open a tax-free savings account, the financial institution will ask you to provide your social insurance number (SIN) and other personal information, including your full name, address, and a government identity card.
Through your TFSA, you can invest in assets like stocks, bonds, exchange-traded funds (ETFs), mutual funds, or Mortgage Fund Trusts. The CRA does not tax any investment income you make in a tax-free savings account. The TFSA is a flexible account, and you can withdraw your money at any time, subject to how liquid your investment assets are.
The Registered Retirement Savings Plan
The RRSP was introduced primarily for retirement savings. Like the tax-free savings account, the CRA sets an annual RRSP deduction limit. This limit depends on your previous year’s earned income, the RRSP limit, and other pension adjustments.
This is how the CRA calculates your RRSP deduction limit:
Your unused deduction room at the end of the previous year
Plus
The lesser of the two following items:
- 18% of your earned income in the previous year
- the annual RRSP limit (for 2021, the annual limit is $27,830)
That exceeds one of the following items:
- your pension adjustments (PA)
- a prescribed amount
Plus
your pension adjustments reversal (PAR)
Minus
your net past service pension adjustment (PSPA)
You can also invest your money through an RRSP, and your investment income is tax-free, provided it remains in the account. If you withdraw money from your RRSP, the CRA will tax your withdrawals based on your marginal tax rate.
To withdraw money from your RRSP tax-free, you can use the Home Buyers’ Plan or the Lifelong Learning Plan (LLP). With the home buyer’s plan, you can borrow up to $35,000 to purchase your first home, but you need to pay this back within 15 years. For the lifelong learning plan, you can borrow up to $10,000 per year for 2 years, for school purposes and repay the money to your RRSP within 10 years.
A notable benefit of the registered retirement savings plan is that your contributions are tax-deductible, thereby reducing your taxes. You can have an RRSP until the end of the year when you turn 71. To receive periodic income from your RRSP without a significant tax impact, you need to convert your RRSP to a registered retirement income fund (RRIF) or purchase an annuity.
RRSP vs TFSA – A Comparison
| RRSP | TFSA |
|---|---|
| CRA registered retirement savings account | CRA registered general savings account |
| Contributions are tax-deductible | Contributions are not tax-deductible |
| Withdrawals are taxed | Withdrawals are not taxed |
| Invest in assets like stocks, bonds, ETFs, mutual funds, REITs, GICs | Invest in assets like stocks, bond, ETFs, mutual funds, REITs, GICs |
| Must close by the end of the year you turn 71 | Can stay open for life |
| Annual contribution limits | Annual contribution limits |
| Suitable for retirement savings | Flexible use for various financial goals |
| You can borrow from RRSP through the first-time Home Buyer’s Plan (HBP) or Lifelong Learning Plan (LLP) without paying taxes | You can withdraw any amount at any time |
| You need an SIN and earned income | You need an SIN and must be up to 18 years of age |
| Unused contribution room is used to calculate your annual contribution limit in the following year | Unused contribution room is accumulated and carried forward |
| To receive periodic income in retirement, you need to convert your RRSP to a RRIF, a life income fund (LIF) if your RRSP is locked, or an annuity | You do not need to convert your TFSA to any account in retirement |
| You can contribute to a spousal RRSP provided you have contribution room | There is no spousal TFSA program, but you can give your spouse money to contribute to a TFSA if they have contribution room |
| Tax penalties for over-contributions more than $2,000 | Tax penalties for over-contributions of any amount |
Factors To Consider When Deciding Between a TFSA Or an RRSP
Tax Strategy
If you fall within a high tax bracket, you can reduce your taxes by contributing to a registered retirement savings plan. Your contributions are tax-deductible, and you can defer taxes until retirement when you generally have a lower tax bracket. On the other hand, if your earned income is relatively low, you can save more using a tax-free savings account.
Also, if you want to withdraw your money tax-free, using a TFSA may work better for you. Lump-sum RRSP withdrawals attract taxes.
Financial Goals
The tax-free savings account is more flexible for various financial goals than the registered retirement savings plan. If you need to withdraw money tax-free for vacation or home repairs, a TFSA may be more beneficial. If your primary goal is
to save for retirement, using an RRSP can help you defer taxes on your high earned income until later in retirement when you fall within a lower tax bracket.
Available Contribution Room
You can only contribute to a TFSA or an RRSP, provided you have contribution room. If you have maxed out your contribution room in your RRSP or your TFSA, you can make contributions into the other account with an available contribution room.
Conclusion
The tax-free savings account and the registered retirement savings plan are both registered accounts that you can use to save and invest. You need contribution room in both accounts to make deposits. While your investment income in both accounts is tax-free, you will need to pay taxes when you withdraw from an RRSP. However, your withdrawals from a TFSA are entirely tax- free. The best account depends on your financial status, earned income, retirement objective, and other financial goals.
