We know we should save money, and we know the best way is to earn money on our savings and to diligently set aside a certain amount each year. But when it comes to deciding on whether to put your money into a TFSA vs RRSP it’s hard to know the right answer, especially when we need to save for both retirement and a rainy day.
The government introduced the Tax-Free Savings Account (TFSA) in 2008, opening up more savings possibilities to Canadians. Since then, many have taken advantage of the savings tool. But many more are still in the dark about what it is and how it can help you save.
A common misconception is that TFSAs are similar to RRSPs, and they are, to an extent. But in very important ways, they are quite different. Therefore, it is important to understand the differences between a TFSA and an RRSP when deciding where to invest your money.
What Is Better: TFSA vs. RRSP?
Where should you put your money? It depends on what you plan to use it for. There is no right answer – just the right solution for your needs. A TFSA certainly sounds more flexible, and it is. But with that flexibility comes smaller returns. To know which is a better vehicle to use to save your money, a TFSA vs. an RRSP, you need to be very clear on what your personal, short, and long-term financial goals are.
TFSA vs. RRSP: Where Should I Put My Money?
Like all investments, the ideal product depends on your contributions, your life situation and your financial and life goals.
When it comes to TFSAs vs. RRSPs, there are some key differences to consider when deciding where to invest your money:
Accessibility Of Funds
A TFSA is a great choice if you want to keep your money accessible. For example, it allows you to withdraw money at any time. So if you have a rainy day and decide to tap into it, you won’t be hit with a tax penalty. Contributed funds are not tax-deductible.
An RRSP, on the other hand, is an investment program specifically meant for retirement. Contributions to an RRSP are tax-deductible, but withdrawals are subject to taxation.
Contributions are intended for long-term investment. You pay a penalty when you withdraw early, called a withholding tax. The tax hit depends on how much you withdraw.
- Up to $5,000, 10% withholding tax
- Between $5,001 and $15,000, 20% withholding tax
- $15,001+ is subject to 30% of the total withdrawal amount
So it’s important to know whether to invest in a TFSA or an RRSP.
Long-Term Contribution Opportunities
That being said, you can only contribute to an RRSP up until the last day of December of the year you turn 71. After that point, the account is closed for all future contributions. There are no such restrictions with a TFSA. If you choose to work into your later years or come into money after the age of 71, you cannot invest in your RRSP. After 71, you either convert your RRSP to an RRIF or buy an annuity.
Carrying Forward Unused Contribution Room
With an RRSP, any unused contribution room is carried over to the next tax year’s contribution room. This carry-forward allowance continues until age 71. A TFSA, on the other hand, has a maximum allowable contribution year-over-year. And unused contribution space cannot be carried forward. If you don’t take advantage of your TFSA annual allowance, you lose that contribution room.
There is one exception: If you’ve never made a contribution in the past. If this is your first-ever contribution to a TFSA, you can make a bulk contribution for the years missed since the inception of the TFSA.
There are significant differences of a TFSA vs. an RRSP when it comes to unused contribution room.
Because both TFSAs and RRSPs have maximum annual contributions, there is a consequence for over contributing.
If you over contribute on your TFSA, you pay 1% per month for the amount of overage sitting in your TFSA. You continue to accrue that interest charge until you remove the excess. Otherwise, when the next calendar year hits, that overage is absorbed into your next year’s contribution.
With an RRSP, however, you have a bit more leeway. You can over-contribute up to $2,000 above your maximum without a hit. Exceed that though, and you pay 1% per month the overage is in the account. And you cannot claim any tax benefit on that amount come tax time.
Number of Accounts You Can Have
The contribution limit is the limit, on both types of accounts. So, you are welcome to have multiple TFSA and/or RRSP accounts. But you can only have the maximum allowance for the year distributed among them.
The Government of Canada has strict guidelines as to the sorts of investments allowed to be held in an RRSP or TFSA. Below is a list of some of the more common types of RRSP and TFSA investments.
Stocks are among the more common investments people put in their RRSPs. The cost of stocks, and their ongoing value, are dependant on the health of the stock market and the success of the corporations in which your money is invested. They can be risky investments in an uncertain market. As far as long-term investments go, the benefit of stocks is that they have time to recover from downward market fluctuations or business-altering events.
Stocks are a great investment for two reasons. First of all, you make money off of upward market trends. Secondly, the company in which you invest often pays out dividends, making them additionally lucrative investments.
Exchange Traded Funds (ETFs) are traded similarly to stock, except instead of a particular company, an ETF is a collection of securities that are traded together on the stock market. An ETF can contain different types of securities, including bonds and commodities and generally have lower management expense ratio (MERs).
Bonds are investments into a government or corporation – a loan. In exchange for your investment, after a period of time you will get your money back, plus interest. They are long-term, fixed investments. As of 2017, Canada no longer sells government sales bonds. But you are able to invest in the savings bonds of other governments around the world that offer them.
In order to invest in mutual funds, you need a money manager who uses pooled funds of multiple investors to invest in a group of stocks or bonds. These investments are typically tied to a specific market or market sectors. People who invest in mutual funds are charged an annual fee that goes to the managers of the funds.
Guaranteed Investment Certificates (GICs) are similar to bonds. You invest a certain amount of money, and in exchange for that loan, you earn interest. The key difference is that, instead of investing in a government agency or a company, GICs are investments into financial institutions.
TFSA vs. RRSP: Type Of Funds That Can Be Contributed
For an RRSP, only earned income goes into this savings vehicle. The contribution is directly linked to the amount of income you reported in the previous tax year.
A TFSA, on the other hand, is more flexible. It allows you to contribute funds from other sources to your account. The allowance is based solely on the government-stipulated yearly allowable contribution. Your earnings are completely unrelated. It’s important to understand the differences in the types of contributions of TFSAs vs RRSPs.
Can I Transfer an RRSP to TFSA Without Penalty?
You can transfer your RRSP to a TFSA without penalty. This makes the process of moving your money within and between institutions easier for investors.
Can You Lose Money In A TFSA?
When your TFSAs do well, you make money. But when they don’t, you lose. That’s why it is wise to choose lower-risk investments for your TFSA if you have lower risk tolerance. Or, if you intend on accessing funds sooner rather than later.
TFSA vs. RRSP: Should I Have Both?
A TFSA and an RRSP serve different purposes. While both are methods of saving, an RRSP has the added benefit of reducing your taxable income. But that is because the money is meant to be stowed away, not to be touched for years into the future. A TFSA is more easily accessible, but with fewer benefits. There is value in, and a need for, both types of accounts, to save for the near and far future. To help you decide where to invest your money, use a TFSA vs RRSP calculator like this one, to help determine which fund to use, how much to put in, and how you will benefit.
What Can You Contribute?
It can be hard to have clarity on what your contributions will do for you long term. It is important, both from a practical perspective as well as from a confidence perspective, to know your investments are helping you plan for your future. Use a TFSA calculator vs RRSP calculator to see how much you benefit from the accounts, and what more you need to do to live and retire comfortably.
TFSA vs. RRSP: Pensions
If you’re one of those few, lucky people with a pension, you might not think you need an RRSP. You’re not wrong, but you’re not right either. Whether or not you contribute to an RRSP on top of your pension depends on a number of factors.
When considering a TFSA vs. an RRSP, take into account potential tax benefits. The fact that your contributions are tax deductible makes the RRSP a worthy savings vehicle to take advantage of, regardless of your pension. By contributing to your RRSP, you will benefit from the deduction at tax time. In addition, you will increase the savings you have at retirement. Win, win. A TFSA does not give you that same tax benefit.
TFSA vs. RRSP: Access
There are very different access rules with a TFSA vs. an RRSP. While the RRSP will give you that break at tax time, it’s locking up your money. A TFSA gives you more flexibility to access your funds, without taking away from the opportunity to grow your money, tax free. If you don’t want all of your retirement savings locked up until the time you are 71, a TFSA, in addition to your pension, makes sense.
It’s important to review your needs and expectations for your retirement savings. Your pension gives you the benefit of having forced savings for retirement and the ability to invest in your RRSP. That doesn’t mean that you should. Talking to a financial professional and having a savings goal and retirement goal helps make that decision easier.
When it comes to deciding on a TFSA vs. an RRSP, there is a lot to know about how to effectively take advantage of the savings opportunities they provide. Sitting down with a professional is always the best way to determine your needs, as well as your goals and strategy. There are some important things for you to consider if you want to go it alone.
This seems obvious but invest as early in the year as possible. The fact is, while it seems obvious, so many of us find ourselves rushing to contribute at the deadline before it’s too late. While it’s not too late to get the tax benefits, by waiting until the deadline, you’re missing out on all of the earning-benefits of having your money in there accruing. Investing a little all year is a much better idea than a lump-sum contribution at tax time. You get the same tax benefit but not the same earning benefit. And that’s a big part of why you’re investing, isn’t it? So don’t wait until the last second. Get the most out of the potential to earn.
If you have a spouse, look into contribution-splitting opportunities. Both a TFSA and an RRSP allow you to contribute to a spousal account. While it doesn’t provide you with an allowance to contribute more than your personal limit, you share the tax benefit of transferring money to the lower earner who can reap more benefits.
TFSA vs. RRSP: Withholding
Ideally, contribute the maximum allowance every year, to both accounts. But, with an RRSP, you can hold your contribution room and carry it over to another year. If you are in a job where your earnings fluctuate year-over-year, it might be worth waiting until a higher-earning year to take advantage of the maximum contribution. To know what makes the most sense and if it’s worth withholding some of your contribution room, use an RRSP calculator. Or, better yet, sit down with a professional to go through all of the pros and cons.
Ideally, you will enjoy a long retirement. Make sure you’re well set up to get the most out of it. The best way is to invest in reliable savings tools that are secure and provide a guaranteed income. Also, ensure your money is invested for growth opportunities. You want to see your money gain value to help provide for your retirement.
And when it comes to deciding on a TFSA vs. an RRSP, there are many things to consider. Sitting down with a professional for a well-thought-out, effective and manageable plan, can help you save today and retire comfortably in the future.