As we head into a new year, it’s time for Registered Retirement Savings Plan (RRSP) deadlines and contribution limits tiptoe back into the conversation. But many Canadians find the differences between Registered Retirement Savings Plans (RRSPs) and Tax Free Savings Accounts ( TFSAs) confusing. Kim Parlee talks to Chris Gandhu, a High Net Worth Planner with TD Wealth, about the differences and how to choose the best plan for you.
- A new TD Bank survey suggests Canadians may be confused when it comes to saving for their future. One in four Canadians aren't sure of the differences between RRSPs and TFSAs. And with the annual RRSP deadline pending, Chris Gandhu, High Net Worth Planner with TD Wealth, is here to walk us through the differences. He joins us from Calgary. Chris, always great to see you. Let's start with the basics. What are the differences between an RRSP and a TFSA?
- Right, Kim. Actually there are a few differences, and maybe the best way to illustrate them is if you walk through this chronologically, contribution to withdrawal, then we can see the differences. So with an RRSP, when you make a contribution you're actually getting a deduction from your total income right up front. That means you're saving tax right away. With a TFSA, there is no such deduction. So the contributions to a TFSA are made with after-tax money.
The other difference is that the contributions to an RRSP are tied to your income, whereas the TFSA contributions is an arbitrarily limit set which only changes year over year based on inflation. And so generally, for an average Canadian, the RRSP contributions are going to be more meaningful than a TFSA contribution.
Now, once the money is in either one of those accounts, it is all invested and grows tax-free. So there is no difference there between an RRSP and a TFSA. But then again, there are some differences at the other end once you start withdrawing the money.
First of all, with an RRSP, it is a pension. So you must withdraw the money, and that happens in the year you turn 71. That's when your RRSP matures into a RRIF and starts paying you a RRIF pension income-- when you're 72 years old. With a TFSA, if you don't want to, you don't have to touch the money. You could stay there for as long as you want.
Now, RRSP withdrawals are also treated as income. So they are taxable. TFSA withdrawals are completely tax-free. And maybe one final difference that's important to note is that if you do make a withdrawal out of your RRSP, either at pension time or sooner, there is no ability to re-contribute that amount. You have to earn contribution room. Whereas with the TFSA, you have some additional flexibility. You can withdraw and you still preserve that original contribution room.
- That, I have to say, is one of the most complete and best answers I've ever had to that question, Chris. I would applaud right now if I could. Let me ask you then--
- Thank you, Kim.
- When someone is going through all that, trying decide between the two, how do you then decide which one to choose?
- You know, if you can, don't decide. Maximize your contributions to both. That's ideal. If you had to choose, I think there are some factors to consider. Your goals are important, your income is important, and perhaps your tax circumstances. Those are the things to look at.
- Let's talk a bit about goals. Give me some examples, if you will-- what goals then are aligned with an RRSP, and what's aligned with a TFSA?
- Right. So if your goal happens to be short-term saving-- so for instance, I want to save some money, but perhaps I need it for a car or a European vacation in a year or two, then the TFSA makes more sense, because you know that you will be pulling the money out fairly shortly and you don't want a tax consequence at that point. If the goal, on the other hand, happens to be long-term savings-- this is income for my retirement that I'm saving for, I'm not going to touch it for a long time-- then RRSP makes more sense, because again, you're saving money upfront in the form of that tax deduction. You have many, many decades of tax-deferred growth, and the contribution room's higher than a TFSA. That helps. And eventually, when you are going to pull the money out, you want to pull it out when your income is low, and that will happen at retirement.
- OK. Income, you said that's an important thing to take into account. So how does your income influence which one you choose?
- Right. So I've sort of touched on this. Again, with the TFSA, the contributions are not tied to your income at all. It's a preset contribution, whereas with an RRSP, they are tied to your income. So your RRSP contribution room is 18% off your earned income in a year, and then there is a statutory ceiling on that, a maximum every year. So if you find yourself to be a higher income earner, then the RRSP is certainly more meaningful, because at 18%, it would lead to a much higher contribution than a TFSA.
But then, again, I think goals, again, important. Going back to that, regardless of your income level, whether it's high or low, if the savings are short-term, I think the TFSA wins.
- OK. I was going to ask you, what if you're high income but you have a short-term goal. So that kind of an answered that one right there. How flexible, would you say, are these plans? I mean, we did talk about-- the TFSA, I think, sounds as though it's a lot more flexible.
- Yeah. I mean, I guess the first thing to note is that this is your money in either account, and you can pull this out whenever you want. So there's no restrictions, or it's not locked in at all. So both RRSP and TFSA offer that flexibility. But like you said, with a TFSA, the income, or the money that you withdraw, rather, is not treated as income, whereas with RRSP it is, except there's a couple of exceptions to note.
So with an RRSP, if you happen to withdraw the money to purchase or to enable you to purchase your first home as a home buyers plan, well, that is not viewed as income, and you can pull up to $35,000 out tax-free. Similarly, if you are going back to school, you now have the ability to withdraw money from an RRSP under the lifelong learning plan, and that's up to $20,000, and that's also tax-free. The catch with both of them is that there is a strict sort of schedule to pay the money back. So just be aware of that.
- All right. Yeah, because if you don't, then I think it gets pulled into your income. Chris, as I mentioned, this is one of the best roundups I've had between the two and explain the difference, and it's always a pleasure having you with us. Thanks so much.
- Thank you, Kim.
- Chris Gandhu-- he is a High Net Worth Planner from TD Wealth, and he joined us from Calgary.