Feeling overwhelmed by RRSP’s & TFSA’s? What are the pros and cons? Which one is right for you? If these questions are boggling you, you’re not alone. Many Canadians are often confused about how to maximize their retirement savings and achieve their financial goals faster. Choosing where to start depends heavily on where you are and where you hope to be, financially speaking.
What is an RRSP?
RRSP’s are a type of an investment account that is registered with the Canadian Government, hence the name “Registered Retirement Savings Plan”. The singular purpose of an RRSP is to aide Canadians with their retirement savings and encourage contributions with benefits like tax deductions and tax-deferred growth on your investment.
An RRSP is unlike an ordinary savings account you would have at your bank because with a savings account you normally would contribute money to that account so that you can withdraw it at any time, an RRSP on the other hand, holds your investments where it will grow with interest, and although you can withdrawal money from it, the process is different. Your investments are more diversified and can include holdings such as companies and interest-bearing investments and the degree of risk vs reward is set to your personal level of comfort. Contributions to your RRSP must follow the guidelines set by the CRA. Your contribution limit, for example, is determined by the CRA to be either 18% of your income from the previous tax year OR the amount decided by the CRA for the current year. You can open an RRSP at any age (as long as you file an income tax return) your investments will continue to grow both during the accumulation phase and when you take money out during retirement, this is known as the distribution phase. During the accumulation phase, all taxes are deferred until you start to take out an income which must start at age 71 but you can elect to take income at any time by converting your RRSP to a Registered Retirement Income Fund (RRIF). Contributions to an RRSP will effectively lessen your reported income for that year and any income tax paid on contributions will be returned to you after you have filed your tax return.
Additional penalties may apply to an RRSP should you choose to withdraw your savings early, so opening an RRSP may not be the right choice for you if you require your money to be liquid while you save.
What is a TFSA?
TFSA’s, or Tax-Free Savings Account’s, are a relatively new option to the savings & investments market, having been first introduced in 2009. Since then, many Canadians have taken advantage of the tax-free growth and tax-free withdrawals on their investments using this type of account.
TFSA’s come with their own set of requirements and contribution limits. Unlike an RRSP, you must be at least 18 years of age and have a valid Social Insurance Number in order to open a TFSA. Your contributions to this account are tax-free while they grow as well as when you withdraw funds. This is, perhaps, one of the biggest benefits to this type of account.
RRSP’s and TFSA’s do share some commonalities, though. Like an RRSP, your TFSA contributions are limited, and these limits are determined by the CRA. If you happen to over contribute to your account, your additional contributions may be subject to tax penalties as determined by the CRA. You are also able to hold a varied type of investments in your TFSA, contrary to popular belief. One mistake we often see is when people use a bank account for their TFSA, the name includes savings account however you are much better off having a TFSA where the rate of return on an investment account could greatly exceed the amount earned on a typical savings account. As a rule of thumb, if your RRSP can hold it, then so can your TFSA. This gives you more options in terms of how you wish to invest in your savings and an experienced financial advisor can you help you evaluate those options at each stage of your life.
RRSP’s & TFSA’s are not mutually exclusive
Although the debate continues about which savings option makes the most sense, your savings plan should not be limited to “either/or”. The “better” option is entirely dependent on the individual and their goals. While an RRSP may be better for reaching your long-term goals thanks to its rigid withdrawal limitations, a TFSA allows your money to be more accessible and used at your discretion. If you can include both in your investment plans, you will maximize the benefits of the RRSP and TFSA without leaving you tied to the limitations of one or the other.
When you’re ready to discuss your financial goals in preparation of your retirement, Darryl Smith with Synergy Life Financial is just a phone call away to help you access the best course of action. Let’s make your money grow with smart investment advice and exceptional services by giving him a call at (705) 434-0562. Not only can he simplify the process, he can also help you reach your goal of retirement sooner than you might think.