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TFSA or RRSP - Which Account Is Right For Me?

Updated: May 31, 2020



One of the most common questions we get from our clients is whether they should contribute their money in a TFSA or RRSP account. The truth is, while they both have their advantages, one might be the better option for you depending on your situation.

Both accounts enable you to save money for different time horizons. Determining which account works best for you will depend on your current and long term goals.


Please explore our resources below to determine the differences and understand the important considerations to help you decide which account type is right for you.

Tax Free Savings Account (TFSA)

 

A Tax Free Savings Account (TFSA) is a registered investment or savings account that allows for tax free gains. It requires individuals to be 18 years or older and have a valid social insurance number to open this type of account. A TFSA can be used for any savings goal and withdrawals can generally be made tax free. This can include investment income, dividends, interest income, or even capital gains. The amount of money that can be contributed to this type of account is limited every year. As you read on, you’ll notice that there are many benefits to a TFSA that can help you save and grow your investments tax free.

The TFSA account enables individuals to use after-tax money to save and grow their contribution tax free - which is a great advantage for individuals who receive income based credits and benefits (i.e. old age security, age credit etc). This account type is ideal for those who are saving for something they'd like to purchase in the near term as it provides a great deal of flexibility and little consequence from withdrawals.


Determining Your TFSA Contribution Room:

Since 2009, your TFSA contribution room accumulates every year from the time you turn 18. Assuming you became eligible since the introduction of a TFSA, your total maximum contribution room would have accumulated to $69,500 in 2020. This is based on the premise that you made no contributions to this account during this time.


For example: If you turned 18 in 2012, your contribution room would begin from there. However, if you were 18 prior to 2009, your contribution room would start from 2009 onwards. Below we have summarized the contribution room for each year starting with the inception of this account.

NOTE: Any changes in the value of your investments in your TFSA account does not impact your annual contribution limit. For example: If you contributed $5,000 in 2009 and earned $300 in investment income, this does not reduce 2010’s deduction limit by $300. Your contribution room will be the full $5,000.


To calculate your ongoing contribution the following formula can be used:

Total Contribution Room = (Your TFSA dollar limit for the current year) + (any unused TFSA contribution room from previous years) + (any withdrawals made from a TFSA in the previous year)

Your TFSA contribution limit can become a little confusing once you start making withdrawals during the year. For example, if you decide to withdraw $10,000 in 2019, this contribution limit will not be available until the following tax year which is 2020 in this case. This is important to note especially in situations where you have no more available contribution limit for that particular tax year as the contribution room has been maxed out.

Another example: Let’s say Bob has contributed the maximum amount to his TFSA since he turned 18 in 2009. In 2020, Bob made his maximum contribution of $6,000 for the year and made a withdrawal of $10,000. This means that Bob, for the purposes of 2020, would not be able to contribute any more money to his TFSA until 2021. This is due to the fact that the $10,000 withdrawal cannot be added back to his contribution room until the following year. If he decides to contribute $10,000 in 2020, he will have an excess amount in his TFSA and can be charged penalties. Lets assume that Bob had a remaining contribution room in the above scenario of $15,500, meaning he did not make any contributions in 2012-2014. Bob could re-contribute the $10,000 he withdrew in 2020 as he had available contribution room in this scenario.

This is important to note since the penalty for over contribution can be significant. For each month you have over contributed, you will be charged a 1% penalty of the highest excess TFSA amount in the month, until the excess contributions have been removed from the account.

If you are unsure about your available TFSA contribution limit, you can access this information through the “My Account” portal on the Canada Revenue Agency (CRA) website.


Impacts of TFSA Losses and Gains

 

Having speculative investments or high risk/volatile stocks in your TFSA account can result in a very rewarding or negative outcome. Since you can purchase marketable securities or investments in this account, you could result in losses or gains depending on your situation.


For example: Let’s assume you invested $69,500 in your TFSA over the years and it has a current market value of $50,000. If you choose to sell these investments and withdraw the entire $50,000, you will lose the $19,500 in TFSA contribution limit. This is significant as losses incurred on investments in this account are not tax deductible so you have lost that much contribution room going forward. However, let’s assume all your stock picks were phenomenal and the market value of your account was $100,000. If you withdrew the $100,000, your new contribution limit for 2021 would be the $100,000 plus the new announced TFSA contribution amount for 2021 along with any unused TFSA room from previous years. Should I Contribute to a TFSA or RRSP - What's the Difference?

A Tax Free Savings Account (TFSA) and Registered Retirement Savings Plan (RRSP) are two different vehicles to help Canadian’s save their money. Each have their own distinct purpose and can be beneficial depending on your own situation.

An RRSP is an investment that enables individuals to benefit from tax deferral opportunities to future years but becomes taxable upon withdrawal. On the other hand, A TFSA enables individuals to contribute after-tax income but does not result in any taxes upon withdrawal. In the chart below, we have highlighted some of the key differences between the two accounts to help provide some guidance for our clients.


As you can see, both accounts let you save money for the future but in different ways. Determining which investing account works best for you will depend on your current needs and long term goals.

 

Disclaimer: The above summaries and information are key highlights into some of the programs available. The information provided above can change based on your specific situation and a professional should be consulted when making complex determinations.


We hope this material assisted you in understanding the difference between the two types of accounts. If you require any help in navigating through the above accounts, please feel free to contact us. We are always here to help!

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