Understanding RRSPs and TFSAs

With tax deadlines coming up soon, let’s go over the basics and benefits of RRSPs and TFSAs.

Registered Retirement Savings Plan (RRSP)

What is it?

The federal and provincial governments encourage people to save for their retirement through the use of RRSPs. An RRSP is a savings plan that individuals establish with qualified institutions (for example, banks, credit unions, trusts or insurance companies) that are registered with the Canada Revenue Agency (CRA), and to which the individual or spouse or common-law partner contribute. RRSP contributions may be used to reduce tax income.

How does it work?

The income you earn in an RRSP is normally exempt from tax as long as the funds remain in the plan. You ordinarily have to pay tax when you take out funds or receive payments from the plan. Withdrawals and payments received need to be reported to the CRA by the institution and the annuitant (the individual named in the plan). The CRA also calculates the maximum that you may contribute to a plan and the annual RRSP deduction limit permitted.

Other types of RRSPs

Spousal RRSPs provide the following benefits:

  • The person who makes the contribution receives the benefit of the tax deduction for the contribution, while the annuitant receives the income and reports it on his or her income tax and benefits return.
  • Spousal RRSPs create a real advantage when one of the spouses is likely to be in a lower tax bracket during retirement. Essentially, the benefit is maximized if a higher-income spouse or common-law partner contributes to an RRSP for a lower-income spouse or common-law partner.

Self-directed RRSPs:

  • are for those folks who want the flexibility to manage a variety of investments within the plan, such as a mixture of cash, stocks and mutual funds
  • may include an annual fee, which may or may not be waived based on the balance in the plan

Tax-Free Savings Account (TFSA)

What is it?

A TFSA encourages people who are 18 or older with a valid Canadian social insurance number to set money aside tax-free. You cannot deduct contributions to a TFSA for income tax purposes. And generally institutions do not issue income tax receipts for the interest earned. However, any amount contributed, as well as any income generated in the account (for example, investment income or capital gains), is ordinarily tax-free, even when it is withdrawn.

How does it work?

The CRA communicates the yearly TFSA dollar limit and lifetime limit. You can only contribute up to your TFSA contribution room (that is, yearly limit minus actual contributions made). Unused TFSA contribution room may be taken forward for use in later years, and the total amount of TFSA withdrawals in a calendar year increases the TFSA contribution room for the next calendar year. Contact the CRA if you are unsure of the amount applicable to you.

How is a TFSA different from an RRSP?

Since TFSAs were introduced in 2009, there has been much discussion about whether they are better than RRSPs. If you qualify to have one or the other, then you should consider having both types of savings plans since they are not mutually exclusive. For example, if you purchase an RRSP and this triggers an income tax refund, you can take the tax refund and put it into a TFSA. Then, if you need cash quickly, you may access the TFSA and not trigger taxable income as you would if you took the cash from your RRSP. When you have no contribution room available in your RRSP or spousal RRSP, you may contribute to a TFSA or vice versa.

Financial and retirement planning is an individual matter; what is ideal for one person may not be so for another. Therefore, educate yourself as much as possible and seek advice from qualified people if you are unsure. In the meantime, opening a TFSA and earning interest tax-free will bring positive returns while you make a medium- or long-term decision.

Bottom line

Contributions to an RRSP are tax-deductible, but taxes are payable when you withdraw from the RRSP. Also, RRSPs may trigger an income tax refund. Unfortunately, you cannot contribute to an RRSP after the year in which you turn 71.

Contributions to a TFSA are not tax-deductible, but withdrawals are tax-free. You may continue to contribute to a TFSA for as long as you have contribution room; there is no age limit.

Contribution limits in 2015

  • RRSP: The maximum allowed is $24,930 or 18 per cent of earned income up to a maximum of $138,500. If you did not make the maximum RRSP contribution in a particular year, the CRA permits you to carry forward the unused contribution room indefinitely and add this to the amount you may contribute for future years. The CRA indicates your annual contribution limit and any carryforward contribution room on the income tax assessment it issues to you.
  • TFSA: The maximum is $5,500 for 2016 ($10,000 for 2015), and if you have not deposited any money in a TFSA since they were introduced in 2009, your cumulative limit is now $46,500.

The author would like to thank David Trahair and the information contained in his March 31, 2015, article, Personal Finance Cheat Sheet.

Keep the conversation going

Do you have any questions on RRSPs or TFSAs? Post a comment below.

Disclaimer

The views and opinions expressed in this article are those of the author and do not necessarily reflect that of Chartered Professional Accountants of Canada (CPA Canada).

About the Author

John Tucciarone, CPA, CMA


John is a graduate of the University of Toronto and has been an accountant for more than 20 years. He enjoys being part of CPA Canada’s Financial Literacy Program and sharing his knowledge and experience.

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