Finances Investing

Differences Between a TFSA and an RRSP

A TFSA or an RRSP is not a glorified savings account. Nor is a place to store your money to be used on the latest Mexico vacation or home makeover.

A tax free savings account (TFSA) should be used to grow your money in a tax free shelter. This is the same with an RRSP. TFSA profits made on investments are not subject to tax when you withdraw your money. This is because the contributions are funded with after tax dollars. This is the exact opposite of an RRSP. Investments for both accounts consist of stocks, bonds, ETFs, GIC’s and mutual funds.

On the other hand, an RRSP (registered retirement savings plan) is an account comprised of pre-taxed investments are taxed when you withdraw money down the road. The tax free money will grow until its time to withdraw the cash. At this time, the CRA will come hunting for their money.

Basically the two accounts are the opposite of one another.

The greatest difference is that a TFSA doesn’t benefit the wealthy as much as an RRSP. The reason? The more you make a year the more you can contribute to your RRSP. This is why I believe your TFSA should be filled first (in most cases) unless you make a high salary.

Lastly, you also need to be working in order to contribute to your RRSP. Anyone over the age of 18 can start investing their money into a TFSA.

Saving Money In an RRSP and a TFSA

RRSP vs TFSA.

  1. TFSA contributions are not tax deductible, RRSP’s are. This means that you can deduct your yearly RRSP contribution from the income you report on your tax return. This can’t be done with a tax free savings account.
  2. You will pay tax on the profit made in an RRSP when withdrawing money. This is because you made contributions with pre tax dollars. This is not the case with a TFSA as you made contributions with taxed dollars (opposite).
  3. You have to have earned an income to contribute to an RRSP. A TFSA does not require any income to be earned. A TFSA has the same contribution limit for everyone if you were 18 and over in 2009.
  4. Both an RRSP and a TFSA allow you to name your spouse as a beneficiary. This means that if you die, your partner will receive the money left in the account (they will have to pay tax on the RRSP). However, I recommend that you actually make your spouse a “successor holder” instead. This means the account can stay open and still grow. Your partner would thank you, trust me.

Key take away.

  • An RRSP lets you defer taxes which is an advantage if your tax rate is lower at the time of retirement. If you make more down the road in retirement, its not as beneficial.
  • TFSA contributions are made with after tax dollars. Therefore if your marginal tax rate is higher later in life, a TFSA can be advantageous in comparison.
  • The max you can contribute to a TFSA if you were 18 and older in 2009 is $75,000, for everyone. The max you can contribute to an RRSP is 18% of your income up to a max of $27,230 per year.
  • Both accounts roll over contribution room. If you don’t fill your account in a given year you can put more in the next.

1. Tax Free Savings Account.

A tax free savings account in my opinion should be filled first. You can open a TFSA and an RRSP at any bank or financial institution in Canada. This process takes a few weeks for the account to become active for investing. At this time you should also make your spouse a successor holder instead of a beneficiary (do the same for an RRSP). This means that if you die, they get control of your account which allows your investments to grow. If they are a beneficiary the accounts are shut down and the money is given to the remaining partner.

Its important to note that you can hold the same type of investments in your TFSA as your RRSP. These include stocks, bonds, ETFs, mutual funds and GIC’s. Bitcoin is currently unavailable for these accounts (thank god).

For a TFSA, on January 1st of every year, there is additional contribution room added to the account. If you were 18 and over in 2009 you can contribute the full $75,000 into your TFSA as of 2021. This is only the case if no previous contributions were made. If you turned 18 in 2013, you can only contribute $55,000 in total (as of 2021).

 YearAnnual contribution limitsCumulative contribution limits
 2009-2012$5,000$20,000
 2013, 2014$5,500$31,000
 2015$10,000$41,000
 2016-2018$5,500$57,500
 2019-2021$6,000$75,500
As of January 1st 2021, you can contribute an additional $6000 dollars into your TFSA. The max is $75,500

The greatest opportunity you have with a TFSA is to start contributing as early as possible. The reason why? Ill show you.

Example: Let’s say you fill your TFSA at the age of 35 with $75,000 and contribute $6000 a year for 20 years. Your investments are in a balanced and diversified portfolio comprised of equities and bonds that grow at a comfortable 7% a year. In the end, you will be left with $536,222 in the account.

If you are fortunate enough to leave it for 30 years, you will be left with $1,137,000. On top of that, the money is subject to no tax. This scenario would have made you an additional $883,000 on your investment.

That is why it is important to fill and use your TFSA correctly.

Things to remember with a TFSA.

  1. It’s easy to take money out of your tax free savings account. Don’t do this. It will prevent you from hitting your retirement goals.
  2. Employers rarely match TFSA. They are more likely to make contributions to your RRSP.
  3. Don’t use this account as a high interest savings portfolio. Buy equities and bonds to put your money to work. You can’t do this with a high interest savings account.

Misconceptions with a TFSA.

Tax free savings accounts are no different than regular savings accounts.

  • Regular savings accounts can only hold cash. TFSA can hold stocks, bonds, ETFs mutual funds and GIC’s.

If you don’t contribute to your TFSA yearly, you lose the contribution room.

  • This is false. If you are 40 today and haven’t contributed, you can add the full $75,000.

Anyone can open a TFSA.

  • You have to be a resident of Canada and be living in the country full time (6 months and longer). You must be over the age of 18.

You can have only one TFSA.

  • This is false. You can have multiple TFSA with different banks. However, the max contribution between all accounts can’t be more than the $75,000 as of 2021.

Registered Retirement Savings Plan.

An RRSP is an investment vehicle geared for your retirement. As most people make less money later in life, they can withdraw their investments at a lower tax bracket.

You can contribute up to 18% of your earned income annually, up to a max of $27,230 a year. Your maximum room is attributed to how many years you have been working and your salary in those given years. You can find this on your tax assessment.

Your contributions can be deducted off of your income tax and you only pay tax when withdrawing your money. All contribution room is carried over so if you don’t max your RRSP in one year, you will have more room the next.

It’s also important to note that if you ever need to take out money before retirement, you can avoid paying taxes in 2 scenarios.

  1. A Home Buyers Plan (HBP): If you are a first time home buyer, you can use up to $35,000 to fund the purchase tax free. However, you must repay the funds to your RRSP within 15 years.
  2. A Life Long Learning Plan (LLP): You can borrow up to $10,000 a year if you or your spouse plan on going back to school. The maximum you can withdraw is $20,000. You will also have to re-contribute to these funds within 10 years.

Positives of an RRSP

The greatest positive of an RRSP is that you can deduct your contribution from your year end income tax. If you make a ton of money one year, you can significantly lower the tax you must pay by contributing to your RRSP. Down to road you would take the money out at a lower tax bracket. Does this sound like retirement?

Because of the 18% of your income contribution rule, RRSP’s predominantly benefit the wealthy. This is not the case for a TFSA. Your RRSP should be filled regardless of your income as it is the best or second best investment vehicle in Canada.

Second, make sure you fill your RRSP with equities, bonds and ETF’s. You can unfortunately purchase GIC’s and mutual funds in this account (Hah). With inflation beating GIC returns and mutual funds having high management fees (MERs), stay away from these investments and don’t waste your money. Remember to make your investments are balanced and diversified.

Third, you have the ability to contribute to your spouses RRSP if you make the account a “spousal RRSP” when you first create it. This means that you have the ability to contribute money and save on behalf of your common in law partner. Basically one spouse can fill his/her own while also contributing to their partners.

The positive of this is you have the ability to income split. Income splitting works works when there is a large disparity between you and your partners income.

The higher earning spouse would fill both RRSP’s as he/she can receive larger tax deduction relative to only contributing to one. As the higher earning spouse is in a upper tax bracket, this deduction will greatly lower the amount of tax that needs to be paid.

In retirement, the lower earning spouse should be doing the withdrawals from the investments. This will make sure the family pays less tax.

Key points of an RRSP.

  • Make sure you re-invest your money in your RRSP. Never let the majority of it sit cash.
  • Take advantage of faster growing investments. Stocks, ETF’s and Bonds preferentially.
  • Avoid GIC’s and Mutual Funds (what the bank will try to sell you) at all cost. I bet you can find a similar ETF with way lower management fees.
  • If you make below average income, fill your TFSA full first.
  • If you have a pension, always have your own RRSP. All pensions are not guaranteed.
  • The last day you can contribute to an RRSP is Dec 31st of the year you turn 71. At this time, the account must be converted into a Registered Retirement Income Fund (RRIF).

Key take away: Let your money grow until retirement.

Differences between a TFSA and an RRSP. Conclusion

Regardless of which investment account you fill first, they both should be fully contributed too. They are important investment vehicles that will provide a significant income source later in life. Early on, they provide significant tax benefits in regards to income splitting and tax deferring. Investments in both accounts grow tax free and should be filled with assets that beat inflation.

I always say that these accounts should be thought of as gifts. They give you the opportunity to have greater income than the old age security and Canadian pension plan combined. If you properly use these accounts, you will have a fulfilled and happy retirement. Basically, never tired when you’re in retirement.

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