Retirement Savings
Retirement savings are on most people’s minds these days. Some people worry about how they are going to be able to live on a fraction of the income they earn. Others want to make the dream of retiring early come true ..fast. Whatever the motivation of saving for retirement is, the basic financial knowledge can come in handy. Today, I am going to cast some light on the difference between two important retirement savings vehicles: a TFSA and an RRSP.
A TFSA
A TFSA (Tax-Free Savings Account) is different from regular savings accounts. It offers versatility, serving as a means to save for immediate goals like purchasing a new car or going on a trip, as well as for retirement planning.
Here are the advantages of utilizing a TFSA:
- Earnings within a TFSA and withdrawals are exempt from taxation (Generally, any investment income you earn within a TFSA is tax-free, except non-qualified investments)
- No fixed contribution deadline allows contributions at any time, with unused contribution room rolling over on January 1 annually.
- You can recontribute the funds that you have withdrawn from a TFSA, albeit after January 1 of the subsequent year.
- TFSA funds can be allocated towards various significant expenses such as educational expenses, home down payments, and retirement funds.
- Your spouse can make contributions to your TFSA without income attribution.
An RRSP
A registered retirement savings plan (RRSP) is an investment and retirement savings account authorized by the Canada Revenue Agency (CRA), designed to aid Canadians in saving for retirement.
Here are the advantages of having an RRSP:
- Contributions made to your RRSP are deducted from your income, leading to a reduction in taxable income.
- Income earned within an RRSP is not subject to taxation.
- Upon retirement, when you begin receiving payments from a registered retirement income fund (RRIF) or annuity, your marginal tax rate may decrease because your earned income is likely to be lower at that stage.
- Both you and your spouse or common-law partner are eligible to contribute to your RRSP.
Which account is better for you?
Here is a comparison between the rules of the two accounts:
TFSA
- You are eligible to open an account as soon as you turn 18 and start earning money, and you are a Canadian resident with a valid SIN number.
- You can contribute for life.
- There is no contribution deadline. You can contribute at any point in the year.
- The government sets the contribution limit for each year. It started from $5,000 in 2009, was raised to $5,500 in 2016, to $6,000 in 2019, and to $6,500 in 2023. It is $7,000 for 2024. The money you contribute is not tax deductible, however.
- If you withdraw money, it can be re-contributed after January 1st, the next year.
- The upfront tax advantage is that you don’t pay any tax on any investment income earned within this account. (there are some exceptions: you cannot hold cryptocurrency in a TFSA, for example.)
- The future tax advantages are that if you have to dip into your savings for emergencies or short-term needs, you won’t face any tax implications. (the withdrawals are not income.) Also, the government doesn’t consider the regular retirement withdrawals as income, so they won’t affect government benefits such as Old Age Security, Guaranteed Income Supplement, GST/HST credits, or other credits and benefits like the Age Credit.
RRSP
- You are eligible to open an RRSP if you earned an income and filed taxes for the previous year, so you know how much you can contribute.
- You can contribute til Dec. 31 of the year you turn 71.
- The deadline for contribution is February 29, 2024 to claim a deduction for the previous year.
- The contribution limit is the lesser of either 18% of your income from the previous year or the annual limit for 2023, set at $30,780, plus any remaining unused contribution room from previous years, subtracting any pension adjustments.
- If you withdraw money, you cannot re-contribute. You lose the contribution room permanently.
- The upfront tax advantage is that contributing to an RRSP can lower your income for current year by putting you in a lower tax bracket, so you will pay tax at a lower rate. Also, any income you make in your RRSP is usually tax-free if it stays in the plan.
- The future tax advantage is that when you withdraw money from your RRSP after you retire, you will pay tax at your marginal tax rate, which often tends to be lower during retirement.
To sum up, TFSA doesn’t provide as many tax benefits, but it’s much more flexible because there are no tax implications for withdrawals. RRSP can offer more significant tax advantages both short and long term. However, it’s less flexible as you have to pay income taxes on any withdrawals you make.
When deciding between investing in an RRSP or TFSA, it’s important to consider a few key factors:
Income:
If you earn more than $50,000, putting money into an RRSP can be beneficial because it provides a tax deduction, lowering the amount of income tax you owe. On the other hand, if you earn less than $50,000, the tax deduction from an RRSP might not be as significant, so investing in a TFSA could be more advantageous.
Purpose of the Money:
RRSPs are primarily designed for retirement savings, which is a long-term goal. TFSAs, on the other hand, can be used for various goals, including short and medium-term objectives like vacations, purchasing a vehicle, or building an emergency fund.
Employer Matching Contributions:
If your employer offers a matching contribution for a group RRSP, it’s wise to take advantage of this opportunity and maximize your contributions to the RRSP.
First-time Home Purchase or Education Funding:
If you’re planning to buy your first home or need to fund your education, contributing to an RRSP can be advantageous. Programs like the Home Buyers’ Plan and the Lifelong Learning Plan are good options to consider.
Expected Marginal Tax Rate When Using the Money:
Consider making RRSP contributions if your current marginal tax rate is higher than what it would be when you withdraw the savings in retirement. Conversely, if your marginal tax rate is lower now than you expect it to be in the future, investing in a TFSA may be more beneficial.
These considerations can help you determine whether to invest in an RRSP, a TFSA, or a combination of both based on your financial situation and goals.
Good luck with your retirement investments!
