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RRSP's vs. TFSA's - What's the difference

September 27th 2016 - Betty Anne Flynn

The most common question I get asked as an Investment Specialist is, “Should I deposit money to a Registered Retirement Savings Plan (RRSP) or to a Tax Free Savings Account (TFSA)?”.  Many people think that these two investments are interchangeable and have similar tax consequences, but this couldn’t be further from the truth. It is important to understand the differences in order to choose the best option for your personal financial goals.  

Registered Retirement Savings Plan (RRSP)

Contributions to an RRSP can be deducted from your annual income on your tax return, resulting in a reduction of income tax payable.  Furthermore, all income you earn within the RRSP is tax sheltered so you don’t pay tax on the income until the funds are withdrawn.  The idea is that when you begin withdrawing funds from your RRSP, you will likely be in a lower tax bracket.

There are limits to how much you can contribute to an RRSP each year.  Your Notice of Assessment, sent to you from the Canada Revenue Agency (CRA) when you file your tax return, shows your RRSP limit for the following tax year.  This limit is cumulative therefore, any unused amount is carried forward in future years. You do however, have to be aware of your contribution room as over contributing to your RRSP in any given year will result in penalties.

The deadline for contributing to an RRSP and claiming it on your tax return is 60 days after the end of the year. 

Tax Free Savings Account (TFSA)

With a Tax Free Savings Account, the tax benefit you receive is exempt from paying tax on the income you earn on this investment.

For example, if you earn $125 interest on an investment, outside of an RRSP or TFSA, then you must include this $125 in your income and pay tax on it when you file your tax return.  However, if this $125 interest was earned on a Tax Free Savings Account, you would not have to include the interest in your income hence, this interest is tax free.

There are limits on how much you can deposit to a TFSA each year and over contributions are subject to penalties.  Provided you were 18 or older in 2009, the lifetime accumulated limit, as of 2016, is $46,500.00, Here are the annual contribution limits to date:

2009   $ 5,000

2010   $ 5,000

2011   $ 5,000

2012   $ 5,000

2013   $ 5,500

2014   $ 5,500

2015   $10,000

2016   $ 5,500

The contribution limit is cumulative.  Also, if you withdraw funds from a TFSA, you can re-contribute the withdrawn amount the next year (or in a future year).  If you turned 18 after 2009, then your cumulative limit starts calculating as of the year you turned 18.

As you can see, RRSPs and TFSAs serve a different purpose. I think the simplest way to look at it is that TFSAs are the wisest choice for any investments that you hold outside of your RRSP. There is a huge difference in tax benefits on RRSP vs. TFSA as unlike an RRSP, there is no reduction in your income for the contributions made to the TFSA. 

Need help deciding which route is the best option for you?  Contact a financial planner to help you work with you to plan what makes the most sense for you and your individual financial situation.