TFSAs and RRSPs: Why not both?

On their own, Tax-Free Savings Accounts (TFSAs) and Registered Retirement Savings Plans (RRSPs) are great for receiving tax benefits and planning for the long-term. But are you using them to their full potential? With the right strategy, you can leverage both products together to help you save for both your short-term needs and retirement.

TFSAs: More savings, less taxes

TFSAs were launched in 2009 as a new savings option for Canadians. All investment growth within a TFSA is tax free, regardless of when or how much you withdraw.

What is one of the biggest benefits of a TFSA? In a word, flexibility. Unlike RRSPs, which can have significant tax consequences on withdrawals, TFSAs allow you to withdraw from the account if needed. This makes them an ideal product for building an emergency fund or saving for mid- to long-term goals.

What are the rules of a TFSA?

1. There are annual contribution limits: You have limits on the amount you can contribute to a TFSA, which is set by the CRA annually (see the limits here).  All TFSA contributions made during the year, including recontributions on withdrawals*, will count against your contribution room.

2. Your TFSA contribution limits are cumulative: If you haven’t opened a TFSA yet, don’t worry! You haven’t lost out on valuable contribution room, even if you haven’t yet opened an account. If you were 18 or older in 2009 (when this product was released), your contribution room grows each year since then. If you are younger, your contribution starts accumulating when you turn 18.

3. There are penalties for overcontributing: If you contribute more than your available TFSA contribution room, you will have to pay a tax equal to 1% per month for each month that the extra amount stays in your account. It’s up to you as the contributor to monitor your contribution room, so keep careful track if you’re going to hold more than one TFSA, especially if these are between different financial institutions.

4. You have multiple investment options available: You can choose from a variety of investment options within your TFSA to suit your savings goals, including variable savings, Guaranteed Investment Certificates (GICs), mutual funds, stocks, or bonds**. Better yet, if you can keep track of your contribution limits, why not diversify your portfolio with multiple investment types?

5. What you earn stays in your pocket: Your investments are tax-sheltered within a TFSA, including the interest and growth earned. That means if you use your TFSA as a long-term investment, over time your account will accumulate much more tax-free growth on top of your initial contribution. Plus, whatever growth your investment has, if you make a withdrawal you are eligible to recontribute the entire amount withdrawn, not just your accumulated limits.

6. Use a TFSA for longer term goals: While you can move money in and out of your TFSA as you need, this might not be the right account if you are saving for monthly expenses, or plan to make frequent withdrawals. This is because there are fees for withdrawals, and frequent withdrawals makes it harder to keep track of your contribution limits and how much room you have left.

RRSPs: A smarter way to save for the future

An RRSP is an account specifically designed to help income-earning Canadians save for retirement.
 
RRSPs are all about long-term planning. Even if your work has a pension plan, RRSPs come with additional advantages:

• They’re accessible before you retire

• You have more control over how your savings are managed

• They’re available to both you and your spouse

What are the rules of an RRSP?

1. RRSPs are not tax-free savings: RRSPs work differently than TFSAs because they’re tax deferred, meaning you don't pay taxes until you withdraw from your RRSP, which reduces the taxable income you owe.  In addition, if you are able to contribute through your employer (pre-tax), it reduces your taxable income at source.

2. There are annual contribution limits: You have limits on the amount you can contribute to a RRSP. The yearly contribution limit is either 18% of your earned income from the previous year, the remaining contribution limit after an employer-sponsored pension plan, or the maximum annual limit for the taxation year — whichever is lowest. Your specific yearly annual and accrued contribution limit will be listed in your most recent Notice of Assessment from the CRA.

3. Income is required for an RRSP: Your contribution room is determined by your earned income, including income you receive from employment, business, and rental properties.

4. You have multiple investment options available: Like a TFSA, you can choose from a variety of investment options within your RRSP, including variable savings, GICs, mutual funds, stocks, or bonds*. Depending on how far you are from retirement, you may want to ask your wealth advisor about diversifying your portfolio with multiple investment types.

5. There are penalties for overcontributing: If you contribute more than your available RRSP contribution room, you will have to pay a tax equal to 1% per month for each month that the extra amount stays in your account.

6. RRSPs have age limits: You can’t contribute to an RRSP past the age of 71. At that time, you can either cash in all your RRSP savings at once (and pay income tax on the total amount, which is not recommended), or convert it to an RRIF, which allows you to make withdrawals as you need and lets the rest of your money continue to grow, tax-sheltered.​

Tying it all together

Although both have their advantages, TFSAs and RRSPs aren’t mutually exclusive. Consider these contribution strategies when creating your savings plan.

1. Contribute to your TFSA if you want to make an RRSP contribution, but need access to your funds. The funds will be available if you need them, and as the end of the year approaches, you can decide how much to transfer to your RRSP. That way, you’ll regain that TFSA room in the next year, since withdrawals made in one tax year can be contributed in future years without impacting that year’s contribution room.

2. Consider keeping some of your savings in your TFSA. Long-term, you can use your TFSA as a way to set aside extra tax-sheltered spending money for retirement. There are two advantages to this: One, you can continue to grow your TFSA throughout your lifetime, whereas you can’t own an RRSP past the age of 71. Two, it provides you with extra savings to fund your retirement travel, entertainment, or other purchases you’ll need after you retire. Because it’s tax-sheltered, funds withdrawn don’t need to be recorded as taxable income.

3. Put your RRSP tax refund into your TFSA. Essentially, you’re using the same dollar twice: You used your TFSA savings to maximize your RRSP contribution, then you used the tax refund from your RRSP to maximize your TFSA contribution.

4. Consider how your RRSP contribution will affect your tax bracket. An extra benefit of putting money into an RRSP is you may reduce your income enough that you can receive benefits and tax credits that come with a lower tax bracket. This includes credits like the Canada Child Benefit, or GST credit. However, you also want to consider what kind of income you will need to maintain your standard of living, and what kind of access you need to your funds.

With any investment plan, it’s wise to talk to your wealth advisor about the best strategy for your individual situation. Fill out our contact form to start the conversation: