Victoria Financial information: Differences Between RRSPs And TFSAs
(NC)-This year, Canadians have the opportunity to take advantage of the government's new Tax-Free Savings Account (TFSA). While most people are scrambling to contribute to their RRSPs, many Canadians are unaware of the basics of the new TFSA. It's worth taking the time to find out how the TFSA can factor into your retirement savings goals.
- Tax deferral vs. Tax savings - there is a big difference. RRSPs offer tax deferral - meaning that nice tax refund that you get because you made an RRSP contribution this year represents taxes you'll eventually have to pay later. The advantage of RRSPs is that you defer the tax payment until a time when your tax rate might be lower (like when you're retired and not working).
When you contribute to a TFSA, you've already paid tax on that money. So if you get a raise in five years and decide to take the kids to Disneyland, you won't need to worry about taking money out of your TFSA because you've already paid the tax. For retirees, TFSAs can be beneficial in addition to RRSPs - use the TFSA whenever you have big lump sum expenses like replacing a car or renovating your house so you can buy what you want without worrying about the tax implications.
- Longevity of the account - This one is simple. There is no age limit with respect to contributions to your TFSA. With RRSPs you can only contribute up to and including the year you turn 71. After that point, you must convert your RRSP to a RRIF. With a TFSA, even people who have to take money out of their RRIF can put funds they don't need right back in their TFSA and enjoy some more tax-shielded growth.
- Contribution limits - Contributions made to an RRSP depend on your income, while TFSA contribution limits increase by $5,000 per year for everyone. Most people can save more money in an RRSP compared to a TFSA, but if you're maxing out your RRSP, it makes sense to save any additional money in a TFSA. To find out how much you can contribute to your RRSP check your most recent Notice of Assessment from the government.
- Rules for withdrawing your money - TFSAs are much more flexible than RRSPs when it comes to withdrawing your money.You don't lose any contribution room if you withdraw from a TFSA. When you withdraw money from your TFSA, you automatically create contribution room in the next year.
This means you can replace what you withdraw in the future without penalty. RRSPs do not allow you to replace your contribution if you withdraw your money, except under the Home Buyer's Plan and Lifelong Learning Plan. This means TFSA's are generally better for short term savings like a wedding or a vacation because you don't lose contribution room and you don't have to pay extra tax.
To find out how much tax you can save with a TFSA and RRSP, use the ING Direct savings calculators at www.ingdirect.ca. More information about the differences between a TFSA and RRSP is available online at www.hugthetaxman.ca.