It's that time of year again when the thoughts of many Canadians turn to putting money away in their Registered Retirement Savings Plan (RRSP) for the future. Actually, that's not entirely true. Many people remember to do it at this time of year because they want to capture the tax deduction against last year's taxes and hopefully get a big refund when they file their returns.
For the longest time, the RRSP was our only way to save tax sheltered money for retirement. Then in 2009, along came a new way to boost your savings with even more attractive features than the long-in-the-tooth RRSP. This new kid, the Tax Free Savings Account (TFSA), brings a truly tax free option to the game, rather than just tax sheltering the money until a later date. But the question is: Is the TFSA the best option for your savings, or is the tried and true RRSP the way to go?
Let's compare the two plans:
|Allows contributors to put away 18% of their earned income to a maximum of $24,930 for 2015.||Money put into the plan can be withdrawn at any time with no tax penalty.|
|Unused contribution room can be carried forward to use in future years.||Unused contribution room can be carried forward to use in future years.|
|Contributors receive a contribution receipt to use as a deduction on their income tax.||No age limit where the TFSA needs to wrap up|
|Offers the possibility of sheltering money earned in higher taxed earning years to avoid those taxes and then taking it out as income in a lower tax bracket later hopefully paying much less tax than you originally would have.||Any interest, capital gains or dividends received from Canadian corporations are tax sheltered (i.e. tax free).|
|High income earning spouses can create a spousal RRSP to reduce their tax liability.||The money can be used for any purpose at any time with no restrictions, penalties, or taxes.|
|All interest, capital gains and dividends received in the plan are tax sheltered, including dividends from US investments, until the money is withdrawn.||Money taken out of the TFSA can be re-deposited to the plan, but not in the same year it was withdrawn.|
|Money received as income from the plan is taxable at your marginal rate in the year it is withdrawn.||Maximum annual contribution limit is lower than the RRSP. $5,500 for 2015.|
|Taking money out prior to retirement is taxed as income (unless it is taken out through the Home Buyers Plan or Life-Long Learning Plan).||Dividends received from US companies are still subject to US withholding tax.|
|The RRSP must be wrapped up by age 71 when forced yearly withdrawals begin.||Contributions to the TFSA are not tax deductible.|
|Money withdrawn from the plan cannot be repaid (unless withdrawn through the HBP or LLP).||No spousal TFSA plans for income splitting.|
If it weren't for the fact that contributing to the RRSP is tax deductible, many people would likely stop using it. It has many more restrictions than its tax-free cousin and in the end, we still have to pay tax on the money when we take it out later (preferably in retirement). I've had people tell me they like the RRSP for the Home Buyers Plan and the Lifelong Learning Plan but the truth is, your TFSA can be used for buying a house, going to school, or many other purposes and you're not required to pay the money back. With the HBP and the LLP, the money has to be repaid in 15 and 10 years respectively, and if it's not, the money gets taxed as income.
The RRSP has to be wrapped up at the end of the year in which we turn 71. At that point, it has to be fully cashed out, converted to an annuity or put into a Registered Retirement Income Fund. If put it into a RRIF, each year the government has a set percentage that must be withdrawn from the plan and reported as income. For those who have enough money from other sources and don't require the income, or want to keep a particular investment without selling it, one strategy is to take the investment out "in kind" at a value equal to the required withdrawal. Once it's removed from the RRIF, any dividends or interest it receives will be taxable but for those who don't want to part with the investment, this is a way to do that. For married couples, another way to legally lower the percentage that has to be taken out each year is to use the age of the younger spouse.
For the TFSA, the government really only cares about three things: How much money went in, what amount was withdrawn, if any, and when did these things happen? As mentioned in the chart above, money can be taken out of the TFSA at any time and can be put back into the plan at a later date, just not the same year it was withdrawn.
If you have extra contribution room, you could even put the money back in during the same year by using up additional contribution room. However, if your contribution room is all used up, then attempting to put withdrawn money back in during the same year it was withdrawn will trigger an over-contribution penalty by the CRA.
Which One To Do First?
If deciding which plan to invest in first, what many people have told me they're doing first is maxing out their TFSA and then, if they still have money to put away for savings, they put it into their RRSP. Some people are doing the reverse; they are saving money in their RRSP first and then putting their income tax refund in their TFSA. That's a variation on the old debate about whether to put money into the RRSP or pay down the mortgage, which was a very popular strategy prior to the TFSA coming on the scene.
Whichever strategy you choose for saving, each one has its benefits, so find the one that works best for you. Whether you're focused solely on saving or doing a combination of putting money away for later and paying down debt, it's all going to help you down the road when the pay cheques stop and we start relying on other sources for the income we need later in life.
Note From Stephen:
I’m a little late posting this very timely article from Christopher so unfortunately the cut-off date for 2014 RRSP contributions has now passed. However, the information found here is good to know anytime.