- Financial Planning
RRSP vs TFSA – Which Savings Plan is Better for You? | Integrated Planning Video Series
November 03, 2022
Prudent financial planning has never been more important than it is now. In our recent Integrated Advisory video series, WealthCo President, Sophie Blais, takes us through the key elements of financial planning. We’ve included a synopsis below.
One of the top questions we get asked regularly as financial planners is what is the difference between a TFSA and an RRSP?
An RRSP is a registered retirement savings plan, and a TFSA is a tax free savings account. There isn't a one size fits all answer to RRSPs vs TFSAs as they are very dependent on your particular planning situation.
Here we’ll provide some general information on both RRSPs and TFSAs.
The Basics of RRSPs
RRSPs were introduced in 1957 by the Federal Government to encourage Canadians to save for retirement. Canadians weren't saving enough and pensions were starting to go to the wayside and the government was worried that most Canadians wouldn't be prepared for retirement. RRSPs allow for you to save a percentage of your income in a tax deferred vehicle. Individuals can put any type of investment with an RRSP as long as it is deemed RRSP eligible. That could include mutual funds, hedge funds, individuals’ stocks, GICs, etc.
RRSPs are a tax deferral vehicle – you don’t avoid tax entirely but you have the opportunity to defer it. When you put money into your RRSP, you reduce your annual taxable income. If you take money out of your RRSP, you increase your taxable income because that's considered income.
The goal with an RRSP is to take income that you earn in high tax years and move that to a low tax year. So ideally, most people believe that when they're in retirement that their income will be lower. If you take out income in a high earning year, you could end up paying additional tax, more than you expected to. That's why it's important to work with your integrated planning team, your accountant, and your advisor to balance out what you're saving versus what you're taking out.
The Basics of TFSAs
TFSAs were introduced in 2009 as another savings opportunity for Canadians. TFSAs work differently than RRSPs in that when you invest in a TFSA, you do not decrease your taxable income. But the investments within the tax-free savings account grow tax free and are not subject to tax upon withdrawal. That’s the biggest difference between an RRSP and a TFSA.
Just like an RRSP, you can invest in multiple different types of investment vehicles within your tax-free savings account, and there are a variety of different objectives or planning considerations as to what you might put in a TFSA. Oftentimes in planning, we'll talk about using the TFSA for shorter term planning objectives.
Withdrawing Funds from Your RRSP
Normally when you withdraw income from an RRSP, you're taxed on that income. There are two situations where that is not the case.
The first is the home buyers plan, where you're able to withdraw a portion of your RRSP to put towards a down payment on a home. It used to be that you could only use this benefit once, now there are some new considerations and people can actually access RRSP money to buy a home a second or even a third time.
The second opportunity you have to withdraw money from your RRSP without being penalized is the lifelong learning plan where you can withdraw up to $10,000 to put towards approved education expenses.
It's important to note with the home buyer plan that you do have to repay what you've withdrawn over 15 years. Same holds true with the lifelong learning program. You can put that money back into your RRSP, but again you do not receive the subsequent tax deduction.
Which One is Right for You?
One of the reasons I like RRSPs, especially with the younger clients or clients who are having a hard time saving, is that it is like a forced savings plan because of some of the penalties that exist if you take that money out early, people tend to be more committed to investing in their RRSP and not touching that money.
For example, let’s say you're saving to buy a new home or you're saving to buy a large purchase item, or you're just really not sure when you might need access to the money. But you know, it won't be at retirement, it'll be before then. TFSAs are often considered more flexible than an RRSP because you can put money in, you can take that money out, and then if you want to replenish the money that you've withdrawn, you can within a certain period of time.
By contrast with an RRSP, when you withdraw income that room is gone. Any future contributions are considered new room within an RRSP. With both plans, you have an annual contribution limit that you're subject to.
Another common question we get from business owners and individuals is what income should I be taking prior to some of the federal programs kicking in, like the Canadian pension plan, old age security, things like that? Tax free income comes out tax free and anything that you pull from your RRSP will be taxed. It's really important to look at all of your income sources, the tax implications to all of those various income sources, and come up with a plan that best meets your needs and manages tax along the way.
Another planning consideration as it pertains to our RRSPs and TFSAs, is group RRSP matching plans as well as group pension plans. I never want to leave money on the table and neither should you. At the end of the day, if your employer or your association is providing matching on RRSPs, or is providing a pension plan, you should definitely take advantage of that.
RRSPs and TFSAs are both great. They both have a really important place in financial planning. One of the common strategies that we use is actually investing in an RRSP and using the tax deduction to put into a TFSA. Another thing to keep in mind is you can invest in both. You don't have to choose one over the other and one might be better one year than the other. Working with your integrated planning team, making sure that the decisions that you're making are in line with your financial objectives will get you the best results.
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