Comptes d’épargne-retraite

Retirement savings accounts in Canada

If you’ve been living in Canada for awhile, chances are you’ve probably heard the terms TFSA and RRSP before. These are the two most common types of accounts that help people save money for a comfortable retirement.

You might be asking, what are the similarities and differences between the Tax-Free Savings Account (TFSA) and the Registered Retirement Savings Plan (RRSP)? “They are both tax preferred vehicles. While the money is in the investment, there is no tax on the investment growth,” says Lyn Greer, a Certified Financial Planner with IPC Investment Corporation.

A simple analogy might be to think of these two accounts like two cars. You can fill the trunk of your car with various items, just like how you can fill these accounts with various savings, investments, GICs, bonds, stocks etc. Both vehicles provide “tax shelter” so that investment income and capital gains can grow inside tax-free in the case of TFSAs or tax-deferred in the case of RRSPs.1 Both vehicles provide some sort of tax advantage and both can help take you to your desired destination of a comfortable retirement. However, the journey to get to your destination may differ slightly.

Which car will you jump into?

TIP #1: Choose investments that match your own risk tolerance and time horizon.

When deciding what items to hold inside your TFSA or RRSP, consider your own risk tolerance and time horizon. Are you risk averse or risk tolerant? Do you need the money five years from now or 10 years from now? These factors can help you determine what percentage of assets to hold in cash type investments vs. bonds vs. stocks.

RRSP Basics

TIP#2: When deciding how much to contribute to your RRSP, look at your reported taxable income and calculate the approximate amount that you would be saving on taxes with an RRSP deduction to determine whether the contribution is worthwhile.

“Marginal tax rates are really important when understanding whether or not a RRSP contribution is worthwhile … Because it’s a progressive tax system (in Canada), the higher your income is, the higher your top dollar will be taxed on,” says Greer. Although there are no set rules, a general rule of thumb is that “RRSPs are very attractive for people that are in higher tax brackets, especially if they anticipate being in a lower tax bracket when they retire.”

Lyn Greer’s recommended steps

  • Determine how much you can afford to contribute
  • Determine what your RRSP contribution limit is
  • Determine the estimated tax savings on the contribution
  • Set up regular payments and have the payments run throughout the year (i.e. every time your paycheque comes in)
  • At the end of the year, consider if it’s worthwhile to continue putting more money into the RRSP

TIP #3: Time your RRSP withdrawals with a “low-income” year.

An important thing to remember is that the RRSP is a tax-deferred vehicle. This doesn’t mean that you can avoid paying taxes altogether.2 When you withdraw money from your RRSP, you’ll be taxed at the marginal tax rate based on your income for the year at that point in time. Since most people withdraw from their RRSP when they retire, they pay less income taxes overall because they are at a lower tax bracket when they decide to withdraw money.

In other words, the basic concept behind the RRSP is that “if you make a contribution in your high income working years and receive a tax deduction, but pay tax on the withdrawal in lower income retirement years, you would save more money in income tax,” explains Greer.

TIP #4: Contribute to your RRSP on a regular basis.

One method is to let money go into your RRSP every time you’re paid. Automate the process so you don’t notice it and don’t have to think about it.  Once it’s set up, you won’t even notice that the money has gone to your RRSP and at the end of the year, you’ll be happy to see that you have contributed so much to your RRSP already.

TIP #5: Remember to check the RRSP deadlines for the year.

You don’t want to miss the deadline! Generally, the deadline is 60 days after the end of the year.

TFSA Basics

On the other hand, contributions to a Tax-Free Savings Account won’t provide income tax reduction benefits. With that being said, “money that goes into it will not be taxed. Even when the money comes out, you won’t have to pay tax on it.” As a result, “when you retire, it may be preferable to have money/investments in your TFSA because when you pull money out in retirement, you won’t have to pay a tax bill,” explains Greer.

TIP #6: The TFSA is not meant to be used for short term savings. Don’t go in and out of your TFSA.

“I like the thought of saving in the TFSA for retirement but the TFSA is flexible in that it allows you to take money out at any point in time. The danger of that is that if someone is saving in the TFSA for their retirement; it’s almost a little too easy for people to withdraw from it. So if they don’t have discipline, it could mean they may not have sufficient funds for retirement,” says Greer.

TIP#7: If you have a “great” defined benefit pension plan, consider  contributing to your TFSA contribution limit first.

Investing in a TFSA is suitable for people who have pension plans, especially for people with defined benefit pension plans (i.e. government workers, police officers, teachers, firefighters, nurses). The advantage to this type of pension plan is that the risk related to retirement income lies with the employer. People who have this type of pension plan are guaranteed a set amount of retirement income based on their years of service when they retire.

As these people already have a large pool of taxable income from their pension, having a pool of income in retirement that doesn’t attract tax will be very helpful.

TIP #8: You can essentially grow your contribution room if you use the TFSA appropriately as a holding place for your investments.

A lot of people may not realize this, but you can essentially “expand” your contribution room because you are allowed to withdraw money from your TFSA and put money back if you wanted to. For example, let’s say a person initially had $50,000 in their TFSA account which was invested in stocks, equities, etc. and the market was doing well so the investments grew to $80,000. The account holder now has the power to withdraw $80,000 in total and put back the $80,000 at a later point in time if they wish. With the TFSA, account holders are entitled to withdraw whatever is in their account and are entitled to put back the amount that they take out.

TIP#9: Start accumulating savings in your TFSA first before contributing to an RRSP if your income now is likely to be lower than five or 10 years from now.

Let’s say that your annual income now is $45,000. If you know that down the road you’re going to have much higher income, it makes sense to first maximize your TFSA contribution room. That way, you can save the RRSP contribution room for the time when you’ll be in a higher tax bracket and can get a lot more money back from a tax refund. When your income jumps, you can always transfer money from your TFSA to your RRSP later.

TIP#10:  Be careful with the TFSA and how it works with the government rules – there are penalties for overcontribution.

If you make a withdrawal from your TFSA and you were at the maximum limit, you’re not allowed to put any money back into your TFSA until the following year. If you do, this might count as an overcontribution, which is subject to a penalty of 1 percent of the overcontribution amount for every month that the excess remains in the account.3

TIP #11: It might be a good idea to have only one TFSA.

The contribution room or limit refers to the maximum amount that you can contribute to your TFSA. Make sure to check the TFSA contribution room on the government of Canada’s website. 4

TIP #12: Get your information from a reliable resource

We’ve only provided some general tips and a high-level overview in this article but there are so many more important details on deadlines, contribution limits, rules, penalties etc. that can’t be overlooked. Make sure to do your research thoroughly from credible sources such as the Canadian government website. Don’t rely on what your friends tell you because they might be forgetting important details.

It would be nice if there were simple benchmarks and clear-cut guidelines to help you decide between investing in a TFSA or RRSP. At the end of the day, it all depends on your individual circumstances. Consult with your financial planner to get advice catered to your custom retirement planning needs.

Thank you to Lyn Greer for sharing these insightful tips.

Disclaimer: This article provides general information and may not be applicable to you. Please consult a retirement planning professional to discuss your personal circumstances. Foresters Financial and its representatives do not offer tax, legal or estate planning services.

1) https://www.nestwealth.com/blog/rrsp-basics

2) https://www.nestwealth.com/blog/rrsp-basics

3) http://www.advisor.ca/tax/tax-news/how-to-fix-tfsa-overcontributions-211653

4) https://www.canada.ca/en/revenue-agency/services/tax/individuals/topics/tax-free-savings-account/contributions.html

416119 CAN (03/18)

Lyn Greer is a Chartered Accountant and independent Certified Financial Planner with Investment Planning Counsel in Richmond Hill, Ontario. She is a past member of IPC’s National Advisory Board and has also volunteered on the Financial Standards Planning Council. Lyn’s specialty is in comprehensive tax planning which is a key focus of her wealth management approach, alongside cash flow analysis, disciplined savings, insurance, and estate planning. You can contact Lyn or learn more at The Greer Team’s official website.

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Florence Lau

Florence is a digital marketer who graduated from the Management & International Business program at the University of Toronto. She spends most of her days wondering about the purpose of life. The other half of her days are spent being a food enthusiast, amateur photographer and blogger.