Thursday, May 25, 2017

TFSA vs RRSP



Hello everyone, today I am going to write about Tax Free Savings Account (TFSA) vs Registered Retirement Savings Plan. A lot of people I've spoken to knows about the two products but don't truly understand the difference between them. To start off, the ultimate aim of these products is to promote you to save money by giving you tax incentive.

TFSA
So what is TFSA? It is a special type of account that was introduced in 2009 that allow people to put money aside and any gain(interest, dividends, capital gains, etc) in that account are tax free. There is a limit to how much you can contribute every year but if you have unused contribution room then you can carry it to next year. If you were 18+ in 2009 and you just decided to open a TFSA today you'll get all the contribution room for the past 8 years.

The name is kind of misleading since it doesn't have to be a "savings" account. It can be a mutual fund account or an investment account.  I am going to use myself as an example, I have a TFSA Mutual Fund Account and a TFSA Direct Investment Account. When I invest into the stock market in my investment accounts the quarterly or monthly dividends I get are not taxed as an incomes when I withdraw it. Remember, you don't have to put it in a savings account.

RRSP
RRSP has been around for a long time, but the concept is similar to TFSA. You can have RRSP Mutual Fund or RRSP Direct Investment. The difference is when you contribute to your RRSP that amount gets deducted from your income when you file your tax. Let say you make $50,000 annually and you contribute $2000 to your RRSP then you only get tax as if you were making $48,000. When you file your tax return you'll get some money back if tax was deducted from the $2000. Some HR department will not deducted the tax from your pay if you let them know ahead of time so you don't have to wait for CRA to give you your money back. However, when you withdraw from your RRSP it'll be taxed as income.

TFSA vs RRSP
Most of my understanding of the two is by reading the CRA website as well as a book call "The Wealthy Barber Returns". The book by David Chillton, he was on Dragons Den for a few seasons, have a whole chapter on this very topic. He breaks it down in details the difference between the two and concluded that they are very similar so it's really a personal choice. Have a read if you get a chance, the book also provides other useful financial information.

  1. Tax - The difference is when do you want to be tax. You'll either pay your normal income tax and take your after tax earning to contribute to your TFSA. Or, you can take your pre-tax earning, contribute to your RRSP and get tax when you take the money out. The key thing to consider is what your tax bracket is right now compare to your tax bracket will be when you retire. 
  2. Flexibility - TFSA is by far way more flexible than RRSP since you can take money our of your TFSA anytime like a normal savings account. RRSP is usually more complicated because of the tax implication during withdrawn.
  3. Contribution - In most cases TFSA has a lower contribution limit than RRSP. TFSA currently has a contribution limit of $5,500 per year plus any unused contribution room from previous years. They also inflation index contribution limit from previous years. RRSP has a contribution limit of 18% of your last years income on your tax return to a maximum of $26,010. Therefore you can actually save more money with RRSP.
One big thing I want to point out for TFSA is the potential for a substantial amount of tax free income. Let say you continue investing the maximum amount every year for 20 year in your TFSA you can easily grow it to a substantial amount. Then all passive income from your investment in your TFSA are now tax free for life. In comparison, any money coming out of an RRSP will be taxed as income. My personal recommendation is to contribute into your TFSA first before RRSP unless your company matches your RRSP contribution. I personally don't have a RRSP since I contribute to a define benefit pension plan with the government. Hope this post helped and if you have any comments feel free to put it in the comment section.

Resource - Here are links to the CRA website for both product.

TFSA - http://www.cra-arc.gc.ca/tx/ndvdls/tpcs/tfsa-celi/menu-eng.html

RRSP - http://www.cra-arc.gc.ca/tx/ndvdls/tpcs/rrsp-reer/rrsps-eng.html

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