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RRSP Vs. TFSA. What’s the Difference?

Canadians have the opportunity to save their money in either a Registered Retirement Savings Plan (RRSP) or a Tax-Free Savings Account (TFSA). But what are their differences? How do we choose the right savings plan?

It all comes down to personal choice and what your needs are. You will be able to go with either one or even both. Both will give you a savings opportunity and allows you to save on taxes. Once you have a clear understanding of both and their benefits, you can make the right decision for yourself.

Let’s explore their differences and learn when to use either one.

What is a Tax-Free Savings Account (TFSA)?

If you’re looking to save over a shorter period, then a TFSA might be the best option for you.

  • A TFSA was first introduced in 2009 to Canadians and has proven its popularity since then.
  • TFSAs got introduced to encourage Canadians to save money.
  • You can start contributing towards a TFSA from 18 years old, and there’s no expiry age.
  • A TFSA is suitable for retirement savings.
  • There is no tax payable on money earned and the money you withdraw from the account due to the contributions coming from your net income, which has already gotten taxed.
  • You can save up to a maximum of $6,000 per year.
  • Any withdrawals made from a TFSA can get reinvested into the same account, but only from the following year.
  • Contributions can get made at any time, meaning there’s no contribution deadline. Whatever contribution room remains will get carried forward to the following year, starting January 1.
  • A TFSA can get used for multiple things, such as a down payment on a home, tertiary education, or any other significant expense.
  • TFSAs are flexible, and you can contribute or withdraw easily without penalty.
  • When you retire, the government won’t take into consideration your TFSA when making a withdrawal.
  • Maximize tax refunds by reinvesting into a TFSA.
  • Only you can make contributions, withdrawals and determine how your funds get invested.
  • Your spouse or common-law partner may receive funds from you to contribute towards their TFSA, but you won’t receive any benefits from the amount you pay, as well as any income earned.
  • As of 2020, your lifetime limit is $69,500.
  • A TFSA is an excellent choice if you’re looking to invest for short to medium-term goals, such as car purchases or an emergency fund.
  • TFSA’s are perfect for you if your income is lower than $50,000 per year.

What is a Registered Retirement Savings Plan (RRSP)?

If you’re looking at long-term savings, specifically for retirement, then consider an RRSP.

  • RRSPs have been around since 1957 to help Canadians save for their retirement.
  • An RRSP allows you to make contributions until the age of 71 years old.
  • No tax is paid on the saved money until it gets withdrawn.
  • Both you and your spouse or common-law partner can contribute towards your RRSP.
  • Up to 18% of your gross income can get saved in an RRSP, or $27,830 for 2021 (whichever is less), with no income tax payable on that money. You’d get refunded for tax after filing your income tax return for that specific contribution year if you invested with after-tax dollars.
  • An RRSP is tax-deductible, as the contributions come from pre-taxed income. You will lose out on pre-tax advantages if you choose not to reinvest your tax refund.
  • Once you withdraw at retirement age, your tax bracket will be lower than your years of earning a higher income. Therefore, the payable tax will be less.
  • Consider taking an RRSP if your employer offers a pension-matched contribution.
  • RRSPs can get used for retirement purposes and education or putting a down payment on a home.
  • Home Buyers Plan – you can withdraw up to $35,000 for a down payment on a home, but you’ll be required to pay it back over 15 years. This “loan” is interest-free when paying back the money.
  • Lifelong Learning Plan – you can withdraw anything from $10,000, up to a maximum of $20,000 per year for school, but you’ll be required to pay it back over 10 years.
  • You must convert your RRSP to an annuity or a Registered Retirement Income Fund (RRIF) by no later than December 31 of the year that you turn 71 years old. If you convert to an RRIF, the government requires you to withdraw a set percentage and report it as income. If you’re married, you can lower the percentage legally by using your younger spouse’s age.
  • If you’re looking to save over the long term, then an RRSP is perfect for you.
  • RRSPs are best if your income is more than $50,000 per year.

Which is Better – TFSA or RRSP?

There is no “better” option, as both plans come with their benefits. Considering the tax benefits of both, along with your annual income, how long you have to save for, and other factors will help you make the best choice for you. Sometimes the best option for an individual is to have both a TFSA and an RRSP.

Whatever your focus is on, be it in retirement savings or short-term goals, having a combination will help you once you reach retirement age, and you need to rely on other sources of income. Considering annual limits and the tax advantages of both savings plans, you should educate yourself on both the pros and cons to make yourself more informed.

Personalize your savings and retirement planning, and consider all your options. It would help if you also considered speaking to a professional financial advisor to help you make the right choice for your circumstances.

Come to discuss that topic in our Facebook Group!

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