TFSA’s vs RRSP’s
Many people have difficulty deciding whether to go with an RRSP or a TFSA, or to have both at the same time. It basically boils down to your personal tax situation and what you envision for your future. The biggest difference between the two is that RRSPs have tax consequences whereas TFSAs do not.
How do RRSPs and TFSAs stack up against each other?
|Tax savings||When you contribute||None|
|Maturity date||Age 71: withdraw or convert to a RRIF||Never|
|Do you need to be earning income to contribute?||Yes||No|
|Contribution limits||18% of your income to a max amount CRA designates that year||$6500 – $88,000, depending on previous contributions|
|Tax refunds||Investable for long-term compound interest||None|
|US dividend stocks||Don’t pay withholding tax||Pay withholding tax|
|High salary and good pension plan?||Possible clawbacks of CPP and OAS||Doesn’t affect CPP and OAS|
|Low salary?||Possible clawbacks of GIS||Doesn’t affect GIS|
|New Canadian immigrants||Unavailable until year 2 of Canadian residency||Available as soon as you move to Canada|
|Funds used as loan collateral?||No||Yes|
Which is best for you?
- If you envision being in a lower tax bracket between now and when you turn 71, put some money into an RRSP. You’ll get the tax break now, and pay less tax on it when you withdraw it at a reduced income level.
- But, if you have a high salary and a very good pension plan now, when you retire your income may still be solidly middle-class once you add in the CPP and OAS payments to your RRSP withdrawals. In this case an RRSP may work against you as it bumps you to a higher tax bracket. A TFSA may be the better bet in this case.
- If you have a low salary and no pension plan, when you retire you may not be eligible to receive the full suite of Guaranteed Income Supplements (GIS) if your RRSP withdrawals bumps you into a higher tax bracket. A TFSA wouldn’t do this to you.
- Because you can’t just withdraw the money anytime you want from an RRSP without tax consequences, chances are you will save it for it’s original intended purpose.
- Because you can withdraw the money anytime from a TFSA, you may be tempted to blow it on trivial purchase decisions.
- If you want to put some money away for a house, wedding, or other large expense in the short- or medium-term, put some money into a TFSA. You won’t get a tax break, but you can get at it whenever you want and it won’t affect your tax situation when you do withdraw it.
You can see that it’s difficult to determine whether a TFSA or RRSP is best as this depends on your personal tax situation. Many people, because of this uncertainty, actually have both types of plans, and contribute money to both. If you choose this route then you have more options vs. having only one or the other, plus you can diversify your income and reduce your overall financial risk.
But with the current employment climate in Canada, the fact that people are working longer, and the likelihood that tax rates and clawbacks are on the rise, a TFSA may be the better bet and more flexible option. And if you are a probable GIS candidate when you are older (due to a lower income during your working years), then you definitely want to avoid an RRSP.
Transferring funds between an RRSP and a TFSA
It is possible to move funds from an RRSP to a TFSA but there are tax consequences for doing so. You can’t simply do a direct transfer between the two accounts…it’s a two-stage process where you first have to withdraw the money from your RRSP (and get dinged by the CRA as this is considered income), temporarily store it in a non-registered account (eg. your regular chequing/savings account), and then contribute it to your TFSA account. Because the CRA will ding you for withdrawing money from your RRSP, it’s best to do this in a year when your taxable income will be lower than usual.
You can also transfer money from a TFSA to an RRSP. The same steps apply but in reverse (TFSA -> non-registered account -> RRSP) but in this case the act of putting money into your RRSP will generate a tax break for you, just like any other RRSP contribution. So it’s best to do this type of transaction in a year when your income is higher than usual.
If you choose to do these types of transfers, make sure you keep track of how much contribution room you have left in each account so you don’t accidentally over-contribute in the same calendar year! And check with your financial institution to see if there is a fee for withdrawing money from either account…some banks have “de-registration fees”.