RRSP Season is Underway! With a lot of our readers being new Chinese immigrant investors to Canada, there is a lot of confusion as to the basics of tax planning.
Here’s a summary of the differences between a Tax Free Savings Account (TFSA) and a Registered Retirement Savings Plan (RRSP) from our new contributor, Joseph Tang, CFA and Investment Advisor at BMO Nesbitt Burns.
Since the introduction of Tax Free Savings Account (TFSA) in 2009, there has been a constant comparison to the Registered Retirement Savings Plan (RRSP) and discussion about which one is more suitable and beneficial. They have their unique benefits and features. In addition, the suitability for the individual is dependent on their specific financial situation and objectives.
To assist us in better understanding TFSA and RRSP, I will provide a breakdown of their similarities and differences.
Similarities between RRSP and TFSA
- Type of Investment Holdings – The type of investments that are held within TFSA and RRSP can be the same. Therefore, we can implement the same strategies and invest into the same solutions in both accounts. Common type of investments that are held are individual stocks, bonds, exchange traded funds, and mutual funds.
- Tax-Sheltered Investment Gains – The returns that we earn in these accounts are not taxable. For example, if we invested into a Balanced Asset Allocation Portfolio in a TFSA or RRSP and earned 6%, then we would retain that amount in the account. As comparison, if we earned 6% in a Non-Registered Account and the tax rate was 20%, then we would only retain 4.8% (6% x 80%) in the account.
- Designation of Beneficiaries – Investors have the ability to designate beneficiaries on both accounts. This provides the ease of passing on the assets to the spouse, children, charitable organizations, etc.
Differences between RRSP and TFSA
- Tax Deductibility on Contributions – The funds that you contribute into the RRSP are tax deductible. This means that you can reduce the amount of taxable income by the amount that you contribute into the RRSP. For example, if you earn an income of $50,000 per year and contributed $8,000 into the RRSP, then your taxable income would be $42,000 ($50,000 – $8,000) instead of $50,000. By contrast, the funds that you contribute into the TFSA are not tax deductible.
- Taxes Incurred for Withdrawals – The funds that you withdraw from the RRSP would be taxable. For example, if you withdrew $10,000 from the RRSP and the tax rate was 20%, then the amount that you receive in your “pocket” is only $8,000 ($10,000 x 80%). However, if you withdrew $10,000 from the TFSA, then you receive the full $10,000.
- Contribution Limit – Anyone who was 18 years old before 2009 has a lifetime TFSA contribution limit of $57,500 as of 2018 (assuming the individual has never contributed into it). On an annual basis, the government increases the limit by $5,500 per year. As you make contributions, the limit is used and decreases over time. However, if you withdrew money from it, then you will get the limit back in the following year.
The contribution limit for RRSP is calculated based on the employment income of the individual over time. Earned employment income increases the limit, while contributions into the RRSP decreases it. The reduction in contribution limit is permanent until it is increased by earned employment income over time.
- Objectives – In general, people utilize RRSP for the purpose of retirement planning. However, it can also be used for Home Buyers’ Plan or Lifelong Learning Plan (topics we would cover in future articles). As comparison, due to the benefits of tax-free withdrawals, people utilize TFSA for a variety of reasons such as down payment, retirement, travelling, and gifting.
The decision to use RRSP or TFSA (or both) is not a straight forward one. It is client specific and dependent on their financial situation. However, the key in building wealth successfully over time is to have a solid savings habit in the financial plan. This is one factor that we have control in achieving your financial objectives!
Joseph Tang is an Investment Advisor at BMO Nesbitt Burns and holds the Chartered Financial Analyst (CFA) Designation. He has been working in the financial industry for over a decade. His passion is to provide comprehensive wealth management strategies and build customized investment portfolios for his clients. He firmly believes in fundamental investing and in active management of assets by adapting to constant changing economic conditions. Furthermore, proper diversification in asset classes, industries, and countries is vital to achieve sustainable wealth for his clients in the future.
Joseph Tang can be reached through his email address: firstname.lastname@example.org