**This is a sponsored post written by me on behalf of Sun Life. All opinions are my own.
Without a doubt, the #1 question I get asked about personal finance is Tax-Free Savings Account (TFSA) vs Registered Retirement Savings Plan (RRSP). Which one should I choose? There’s no simple answer since both have their benefits. Here’s why I suggest you use both.
To be honest, it’s easy to understand why people don’t get how an RRSP works or how you can maximize the use of your TFSA. Both have their own unique rules.
To help clarify the TFSA vs RRSP debate, I’m going to explain the differences as best I can. You can then figure out how you can start investing or save more.
The differences between a TFSA and an RRSP
|What’s my contribution room?||Accumulated annually when you turn 18||18% of your prior-year earned income to a maximum amount|
|Does contribution room carry over?||Yes||Yes|
|Are contributions tax deductible?||No||Yes, reduces your taxable income|
|Tax rules?||Tax-sheltered growth||Tax-sheltered growth|
|Investment options?||Multiple investment options available||Multiple investment options available|
|Are withdrawals typically taxed?||No||Yes, at your marginal tax rate|
|Consequences of withdrawing?||None. You can recontribute the withdrawn amount in the following year||You may permanently lose that contribution room and be subject to tax on withdrawals|
|Expiration date?||None||You must convert the RRSP assets into income, either as a cash withdrawal, by way of a Registered Retirement Income Fund (RRIF) or a Payout Annuity by the end of the year you turn age 71|
How to Invest in a TFSA and an RRSP
TFSAs and RRSPs allow you to hold a variety of investments such as mutual funds, guaranteed investment certificates (GICs), Insurance GICs (guaranteed interest contracts), segregated funds, stocks, bonds, and more.
What’s convenient about TFSAs and RRSPs is that there are multiple ways to manage them, including:
- Through your bank,
- With an investment or financial services firm,
- Do-it-yourself trading, and
- Robo advisors.
Many people who are looking to set up their TFSA and RRSP go to their bank first. This is a good solution if you want to get started. But, it may not be the best bet for the long-term. That’s because bank employees may be trained to only sell their own products.
Another option is to use a financial services firm such as Sun Life that offers both TFSA and RRSP registration types, along with many different product options that can be held within these registration types. Sun Life partners with advisors across the country who can speak different languages and can explain your investment options. Sun Life also has web based tools and resources available if you want to learn more about personal finance and investing.
People who prefer a hands-on approach will likely want to go the do-it-yourself route. Depending on your investment strategy and investment knowledge, you may need to dedicate some extra time to research if you choose this option.
Finally, robo advisors are for people who want low fees and a hands-off approach.
When you should use an RRSP
- If your company matches RRSP contributions
- If you plan to use the money for your first home or to continue your education
- You want to use your tax refund to pay down debt or to reinvest in your RRSP/TFSA
What makes RRSPs appealing is that contributions are tax-deductible. What that means is that you lower your taxable income when making a contribution, which is why you’d likely get a refund. Everyone wants money back in their pockets, but that doesn’t mean an RRSP is the right fit for you.
Generally speaking, people in a higher income bracket benefit the most from RRSP contributions. For example, if you make $100,000 in taxable income and you contributed $10,000 to your RRSP, your taxable income would be $90,000. Since you’d pay about 40% in taxes, you’d get $4,000 in tax savings when contributing to your RRSP.
I’m not suggesting that only people with a high income should contribute to an RRSP. If your company matches contributions, then you should definitely sign up. For those who have an income above $50,000 and don’t expect their salary to increase much more, an RRSP can be a great tool for their retirement savings.
If your company matches RRSP contributions then it’s beneficial to you since it’s like getting free money for your retirement. Every company has different rules when it comes to matching RRSP contributions, so be sure to ask your plan administrator or benefits provider for more details.
You want to contribute to your RRSP when your tax bracket is high and withdraw from it when your tax bracket is low. I realize that’s easier said than done.
The amount you can contribute is based on 18% of your earned income from the previous year, up to an annual limit ($27,230 in 2020). This contribution room carries over to a subsequent year, if unused in the current year.
When to use a TFSA
- You have a short term savings goal
- You need a place to put your emergency savings
- Your company has an RRSP matching program or pension plan
- Your RRSP is maxed out
- You think you’ll be in a high income tax bracket when you retire
TFSAs are a bit easier to understand. If you’re saving for a short-term goal such as a wedding, vacation, car purchase, home renovation, or emergency fund, a TFSA is a great place to park your money. If your company has an RRSP matching program, using a TFSA is still useful. That’s because you’ll likely have a limited room left in your RRSP anyways. The same theory applies if you have a company pension plan. Since you’ll have limited RRSP room available, you might as well try and max out your TFSA.
The TFSA annual contribution room limit ($6,000 in 2020) is indexed to inflation and rounded to the nearest $500. To see the contribution limit increases over the years, check out the Government of Canada’s website.
I mentioned above that investing in your RRSP is beneficial when your company matches contributions, but it can also be good for your TFSA. The assumption is that since your company is matching RRSP contributions, you might have extra money saved so you can put that towards your TFSA.
Now, if you’re lucky enough to have a pension through your employer, you’ve probably noticed that you have limited room in your RRSP due to your pension adjustment. If that’s the case, it may be more beneficial to contribute any additional savings towards your TFSA.
RRSPs and TFSAs aren’t that complicated, but it can be tough at times to figure out which one is best for you. If you’re still not sure, talk to a professional who can guide you through the process and answer any questions you may have.
The RRSP vs TFSA debate will never end, but with the knowledge you’ve gained, you can start making smarter money decisions. I’ve focused on the tax breaks. But if you’re ever in a position where you’re able to max out both options, do it. It’s never a bad thing to save more money.