Registered Retirement Savings Plans (RRSP) and Tax-Free Savings Accounts (TFSA) are two investment options for Canadian citizens. RRSPs have various tax advantages compared to investing outside of tax-preferred accounts and are designed for long-term investment. TFSAs are a short-term investment option and, unlike RRSPs, have no tax penalties for early withdrawal of funds. Income earned in a TFSA — including capital gains and dividends — is not taxed.
|Stands for||Registered Retirement Savings Plan.||Tax-Free Savings Account.|
|What it is||A Registered Retirement Savings Plan is a type of Canadian account for holding savings and investment assets. RRSPs have various tax advantages compared to investing outside of tax-preferred accounts.||The Tax-Free Savings Account is an account that provides tax benefits for saving in Canada. Investment income, including capital gains and dividends, earned in a TFSA is not taxed, even when withdrawn.|
|Primary Purpose||Retirement savings.||Any or general savings.|
|Taxes||Contributions are tax deductible, while withdrawals are subject to taxation.||Contributions are not tax deductible, but withdrawals are not taxed.|
|Contribution Limits||18% of previous year’s income, up to $24,270 (for 2014).||$5,500 (in 2014).|
|Age Limits||Contributions must stop the year after the account holder turns 71.||No age limit.|
|Approved Assets||Savings accounts, guaranteed investment certificates (GICs), bonds, mortgage loans, mutual funds, income trusts, corporate shares, foreign currency and labour-sponsored funds.||Savings accounts, guaranteed investment certificates (GICs), bonds, mortgage loans, mutual funds, income trusts, corporate shares, foreign currency and labour-sponsored funds.|
|Early Withdrawal Penalties||Subject to withholding taxes.||No penalty for any withdrawals.|
|Special Withdrawal Programs||Homebuyer’s Plan; Life Long Learning Plan.||N/A.|
|Foreign Investments||Suitable for foreign investments. No limit on foreign content.||Not good for foreign investment. Not recognized by the IRS as a tax sheltered vehicle, 15% withholding tax on dividends.|
|Early Death||Unless transferred to a spouse, treated as income, and taxed accordingly.||Money in a TFSA is not treated as income.|
|Income Levels||Withdrawals are considered taxable income.||Withdrawals are not considered taxable income.|
Using RRSPs and TFSAs
RRSP are open to any Canadian citizen over 18 years of age. They are dedicated retirement accounts and are designed for long-term savings and investments up to age 71 (at which point an RRSP is cashed out or converted to a RRIF). As contributions are deductible and tax-deferred—i.e., taxes are paid only upon withdrawing funds—RRSPs are generally good for retirement as most people move into a lower tax bracket once they stop earning a regular income from a full-time job. The money in an RRSP is less accessible than with a TFSA, reducing the temptation for early withdrawal.
Different types of RRSP accounts are available, including individual, spousal, or employer-sponsored. Some employers offer to match employee contributions in the same way some U.S. employers match 401(k) contributions. RRSPs are ideal for self-employed Canadians.
TFSAs are geared more toward short-term savings goals, like vacations, a new car, or wedding expenses, etc. When used in long-term financial strategies, TFSAs are useful for managing one’s position in national tax brackets. Because funds withdrawn from these accounts are not considered income, those with a high income can use TFSAs to reduce their taxable income, and those with a lower income can use the accounts to lower their taxable income to retain certain government benefits.
This video explains the differences between RRSPs and TFSAs:
Annual contributions to RRSPs are limited to 18% percent of the previous year’s income, or up to $24,270 in 2014. Annual limits are indexed to changes in the average wage in Canada.
The 2014 annual contribution limit for a TFSA is $5,500. However, people who are just beginning to fund their accounts can pay in for all previous years they missed, going back to 2009 for every year that they were Canadian residents and over the age of 18 (up to a total of $31,000).
- 2009: $5,000
- 2010: $5,000
- 2011: $5,000
- 2012: $5,000
- 2013: $5,500
- 2014: $5,500
Currently, neither RRSPs nor TFSAs offer very high interest rates (usually <3%), meaning money growth in either account is slow. TFSAs are still advantageous to use because of their tax-free nature. When it comes to RRSPs, interest rates increase over time, but individuals should consider investing their savings in the stock market, bonds, or mutual funds to help grow their money.
Early withdrawals from RRSPs are subject to a withholding tax rate between 10% and 30%. The money received after taxes are withheld is still considered taxable income and is subject to additional taxation. This double taxation is intended to discourage early withdrawals. There are two exceptions: first-time home buyers can withdraw $25,000 per spouse to make a down payment (this money is tax-free as long as it is paid back within 15 years), and individuals can also borrow up to $20,000 to pay for higher education under the Lifelong Learning Plan (up to $10,000 per year), which is tax-free if paid back within 10 years.
TFSAs are not subject to any early withdrawal penalties.
RRSPs were established by the Canadian government in 1957 with the intention of encouraging employees and self-employed individuals to save more of their money for retirement. Originally created with a 10% foreign content limit, the limit was raised in 1994 and 2001, and then was abolished altogether as it became clear that the limit was merely generating fees for fund managers (as synthetic foreign funds allowed people around the limits anyway). In 2007, the age limit for transferring the account to an RRIF or annuity was raised from 69 to 71.
TFSAs were introduced in 2008 and became effective on January 1, 2009. The basic idea was to give people a good place to set up a rainy day fund, but the accounts have quickly proven to be versatile — or people have proven to be financially creative — and have been used to manage income levels for tax or benefits. TFSAs have been applauded as a well-conceived government program, but many Canadians are unaware of or confused about TSFAs.