RRSP & TFSA

What do they mean & what is the difference!

February 19, 2019

I get this question a lot. Investors asking how much they should put in each, what are the benefits & what does the acronym stand for. As a CERTIFIED FINANCIAL PLANNER® professional I am well versed in the world of financial acronyms. RRSP stands for Registered Retirement Savings Plan and TFSA stands for Tax-Free Savings Account. There’s an entire alphabet soup dedicated to the different account types available to Canadian investors. But its winter and I’m sick of soup, so we’ll save those for another day.

Let’s first start with the RRSP. An RRSP is a type of account in which you hold investments and those investments are sheltered from tax until you withdraw them. An RRSP is an account type and not an investment in itself. The benefits of making a contribution to an RRSP are 3 fold;

  1. Any contributions made to an RRSP are deducted from your income. For example, if your taxable income for the year is $100,000 and you contribute $20,000 to your RRSP, your taxable income is now $80,000. If you are employed and receive a T4 in February this means that the taxes the CRA withheld from you over the year on the additional $20,000 will be returned to you in the form of a tax refund.
  2. The investments in the account are sheltered from tax until you withdraw them. The growth your investments enjoy while inside of the account aren’t taxable. They are taxable when you go to withdraw them most likely sometime between your 55th birthday and the year you turn 72.
  3. Once you start withdrawing from your RRSP or you convert to a RRIF (Registered Retirement Income Fund) your withdrawals are now added to your income. The higher your tax bracket when you’re working and the lower your tax bracket when you’re retired and withdrawing the funds the more advantageous an RRSP is to you.

A TFSA is a type of account with a misleading name. A common myth is that a TFSA can only be used like a savings account you have at the bank. It is very rare that this is the most beneficial way to use a TFSA. The greatest benefit usually comes from having a long-term focus. Here’s why. It works the same as an RRSP in the sense that it can hold many types of investments but there are 3 key differences;

  1. It’s TAX FREE! Any investment that’s eligible to be held in a TFSA is completely tax free! No capital gains tax, no income tax, no any tax ever!
  2. A TFSA uses after tax dollars. You don’t receive a tax deduction nor a refund when you make a TSFA contribution.
  3. When you withdraw the funds you don’t owe any taxes. This removes the downside that an RRSP has where you could withdraw contributions that were made at a high tax rate.

In summary, an RRSP is a tax deferral account where you’re deferring the taxes owing from the time you make the contribution to when you withdraw. A TFSA is a tax-free account where you’re using after tax dollars to shelter your investments from tax. There’s no black and white answer as to which one is better, it depends on each individual investor’s needs. What is your time horizon? What are you saving for? How much will you need to withdraw and when?

If you’d like to hear more on which option is better suited for your needs, give me a call. I’d like to help you navigate through this difficult financial landscape and help you live life confidently.

 

Dylan Wilson

Cattelan Private Wealth Counsel Team