TFSA vs RRSP

First of all, I would like to start off by wishing everyone a Happy New Year. It’s a new year with new beginnings, which is actually one of the reasons why we have started this quarterly newsletter.

This is the first newsletter of many to come. We will discuss relevant topics of taxation and accounting that apply to common everyday situations. But more importantly, we will keep it in simple, plain English as opposed to packing in complicated accounting nonsense. Since it is that time of the year for RRSP contributions, it only makes sense to begin our newsletters with a discussion on RRSPs verse TFSA accounts and which one is better for you.

RRSPs

Now, a RRSP is a type of bank account that can be opened at any financial institution which is used to hold savings and investments. There are many different types of RRSPs such as Mutual Fund RRSPs or GIC RRSP, but all have the same fundamental characteristic: contributions to an RRSP reduce the amount of earned income for individuals. As a result, you’re effectively deferring the tax you pay on your income to a later period such as retirement. The purpose of this is to provide an incentive for individuals to contribute when they’re in a higher tax bracket and withdraw later, such as retirement when an individual is in a lower tax bracket.

You may ask what is your contribution limit for the year, well that’s based on your income. For 2015, your RRSP contribution limit is 18% of earned income up to a max of $24,930. In other words, an individual may contribute up to $24,930 to help reduce earned income with then subsequently reduces taxes payable.

TFSAs

TFSA accounts are relatively new and has been one of the biggest changes to Canada’s savings options since the introduction of the RRSP. Introduced in 2009, individuals are able to make contributions to a TFSA account, and any income generated inside this account is considered tax free. An individual begins accumulating their contribution at the age of 18, but in British Columbia an individual is required to be 19 or older to open a TFSA account. Any contribution room from a previous year are carried forward indefinitely. CRA has set out contribution limits for each year which are as follows:

2009, 2010, 2011 and 2012 – $5,000;

2013 and 2014 – $5,500;

2015 – $10,000

That means, if you have not made any contributions into your TFSA since 2009, you may contribute $41,000 in the current year. CRA does allow withdraws from a TFSA account but an individual must wait until the following year to get that contribution room back. For example, John deposits $10,000 into his TFSA account on March 31, 2015 (for illustrative purposes, assume that he has contributed the max amount each year since 2009). He decided to withdraw $5,000 on June 30, 2015 to pay for an unexpected car repair. This is perfectly acceptable per TFSA rules. However, on October 31, 2015 John thinks he can still contribute the withdrawn amount from June so he makes another contribution for $5,000 bringing his total contributions in 2015 to $15,000. This is not allowed per TFSA rules and John will have to wait until 2016 before making the $5,000 contribution. Any contributions that exceed the limit are subject to a 1% penalty each year calculated on the excess.

Which is better for you?

Which one is right for you? Well that depends on whether you require the money on a short-term basis and which tax bracket you expect to see yourself in at the time of contribution and withdrawal. If you expect your tax rate to be lower during retirement, then an RRSP may be preferred. However, if you expect your tax bracket to increase in retirement, then contributing to a TFSA may be more advantageous. Either way, both system encourage savings and provide incentives in their own way.