Registered Retirement Savings Plans (RRSPs) and Tax Free Savings Accounts (TFSAs) are the go-to products for Canadians who are serious about socking away some money for the future, whether it’s for retirement or for a big purchase, like a house. While the two products are similar in many ways, there are also a number of areas in which they are not. These differences may seem a little ‘duh’ for some, but laying out the obvious is a good start as you consider the more complicated question of which one is right for you—whether you’re just beginning to make the decision or if you’re rethinking your current strategy. Here are seven simple things that differentiate RRSPs from TFSAs.
1. How old they are
RRSPs have been around a lot longer than their tax-free cousin. The RRSP was introduced in 1957 by the Liberal government of Prime Minister Louis St. Laurent. Fifty-one years later in 2008, the Conservative government of Prime Minister Stephen Harper rolled out the Tax-Free Savings Account.
2. Age restrictions
There is no minimum age for starting an RRSP, but you do need to have an income. The very last day you’re allowed to contribute to your RRSP is December 31 of your seventy-first year. Meanwhile, you can’t open a TFSA until you’re at least 18 years old and there’s no upper age limit for contributing to the tax-free savings vehicle.
3. Contribution limits
If you are not a member of a registered pension plan (RRP) or deferred profit sharing plan (DPSP) through your employer, the RRSP contribution limit for 2016 is 18% of your 2015 income up to a maximum of $25,370. So if you earned $45,000 last year, your contribution limit this year will be $8,100. The TFSA contribution limit this year for all Canadians over 18 years of age is $5,500, regardless of income. Also, any unused TFSA contribution room rolls over each year. In fact, an adult who was 18 when the savings tool was introduced in 2009, would have accumulated $46,500 in contribution room, as of 2016.
4. How your money gets taxed going in
This one’s a biggie. Contributions to RRSPs are made with before-tax money. In other words, you don’t pay income tax on RRSP contributions, which makes for a larger tax refund when you file your return. Alternately, TFSA contributions are made with after-tax money. This means you have already paid the income tax on any money put into your TFSA so it can’t help lower your tax burden like the RRSP.
5. How your money gets taxed while inside
Psych! No difference here. Both RRSPs and TFSAs allow money and investments to grow tax-free while inside the respective products.
6. How your money gets taxed at withdrawal
Another biggie. As RRSP contributions are tax deductible, any withdrawals made from your RRSP are taxed in accordance with your income that year. Contributions to your TFSA have already been taxed, so any withdrawals you make are tax-free. This means that any growth you earned inside your RRSP is taxable but the growth earned inside your TFSA is, well, tax-free.
7. What happens after you withdraw
Both RRSPs and TFSAs allow you to carry forward unused contribution room. However, if you choose to withdraw funds from your RRSP, the contribution room is lost and you don’t get to replenish it later. On the other hand, if you take money out of a TFSA, the amount withdrawn will be added back to the next year’s contribution room.
Both RRSPs and TFSAs are excellent products to help you grow your savings, and understanding their differences will help you choose which one is right for you.