RRSPs versus TFSAs
So let's assume that you've decided to start saving for a long-term objective,
such as retirement. As a Canadian, you can choose between two main tax-sheltered
types of accounts. The Registered Retirement Savings Plan (RRSP) lets people
subtract the money they put in from the income they report on their tax forms,
but then they have to pay tax on the money when they take it out. The Tax-Free
Savings Account (TFSA) doesn't let people subtract the contribution from their
income on their tax forms in that year, but they don't have to pay tax on the
money when they take it out. (By the way, for US readers, the RRSP is something
like the IRA in the US, and the TFSA is something like the Roth IRA. I'm not
going to talk about those here - you should find another article about them.)
How are they similar?
The RRSP has been around since 1957 and the TFSA has only been around since
2009, but there are lots of things about them that are similar:
- You can generally establish accounts for either in most of the same places.
You can set them up at a bank, a brokerage, an on-line broker, and a bunch
of other kinds of places.
- You can generally keep the same kinds of things in them: stocks, bonds,
mutual funds, ETFs. You can probably even hold pork bellies in your RRSP or
TFSA if you want to.
- With either of them, you can choose how much hand-holding you get from the
place where you set up your account. For example, most of the accounts you
set up at a bank are structured so that the bank has a duty to advise you
on what investments you should make, based on your risk tolerance and the
amount of time until you will need the money. At the other end of the scale,
you can set up a "self-directed" account at an on-line broker, and
they will pretty much leave you alone to make your own choices.
- With both of them, you don't have to report the earnings of the account
when those earnings are just staying in the account and not being given to
you. They act differently when you start taking money out.
How are they different?
From a tax standpoint, RRSPs and TFSAs are kind of inverses of each other,
but there are also other differences:
- When you put your money into your RRSP account, you are allowed to subtract
the amount you put in (as long as you didn't exceed your limit for the year)
from the income you report on your tax form. In fact, if you put it in before
then end of February, you can subtract the amount from the previous year's
income. Then you'll get a tax refund just a couple of months later. When you
put your money into your TFSA, you don't subtract it from your income on your
- When you take the money out, you have to pay tax on your RRSP withdrawal
as though it is new income in that year. When you take money out of the TFSA,
you don't have to report it as income or pay tax on it.
- One implication of that is that the income that happens in an RRSP during
the years when it was just growing does get taxed as you remove it. The income
that happens in the TFSA during its years of growth never actually gets taxed.
- The other implication is that the RRSP kind of lets you move the year when
income seems to occur, from the viewpoint of Canada Revenue. Basically you
are canceling some income in the current year and having it pop into existence
in a much later year. You would do that if you think your current income is
likely higher than it will be when you need the money. If you think you make
less money now than you likely will when you need the money, you should not
use an RRSP. A TFSA is a much better plan for that situation.
- A lot of institutions are marketing TFSA accounts that are basically just
savings accounts or GICs. (Not sure why, but RRSPs like that are not pushed
to the same extent.) That would mean you'd be saving for a long-term objective
using only the "cash" category of investments. Go back to Canto
2 to find out why that's dumb. Also, you're going to all the trouble of
setting up this fancy type of account in order to get a tax break on a minuscule
amount of income. If you're not going to hold income or equity types of investments
in your TFSA, don't even bother.
- They have different contribution limits. In 2014, you can put up to 18%
of your previous year's income up to a maximum of $24,270 into an RRSP. You
have to adjust this if your employer provides a pension for you. You can put
up to $5,500 in a TFSA. In both cases, unused contribution limits from previous
- You can't put any new money into an RRSP after you are 71. You have to roll
it over into a Registered Retirement Income Fund, after which it is mandatory
to start taking the money out. You don't have to stop funding a TFSA after
71, or take money out of it if you don't want to.
- There are only two reasons you can take money out of an RRSP before retirement,
without paying penalties: buying a house, or pursuing a higher education.
Then there are strict requirements for paying the money back in. The TFSA
is much more flexible about allowing withdrawals.
What if you have to file taxes to the US?
My kids are dual citizens, so once they get beyond a certain income threshold,
they're going to have to file to the US. The RRSP is recognized as a retirement
tax shelter by the IRS, and although you still have to report it in a couple
of ways, it's not all that onerous.
The TFSA requires the same level of reporting as we've been doing for the Registered
Education Savings Plan (RESP):
- We report the income on our 1040 form,
- We report it as a foreign account on the Foreign Bank Account Reporting
- We have to make up our own 3520A form even though the IRS seems to expect
our bank to do that for us,
- We have to fill out the 3520 based on the 3520A we made up, and
- We have to report the mutual funds held in the account in a 8621.
We're filling out all these forms for accounts on which we have never owed
any tax to the US, but if we don't fill them out (or if we screw them up) we
can be subjected to fines. It's truly ridiculous. So if you have to file to
the US, think twice before setting up a TFSA. If you're not comfortable around
tax forms, you're going to need lots of help.
So which should you choose?
If you make less than about $43,000 per year at the moment, you probably don't
want to start an RRSP. Chances are you'll be making more money in the year when
you want to use the money, so you'll pay more tax altogether. If you're making
less than that, you should probably choose a TFSA. (If you have to file taxes
to the IRS, get some help to figure out what it's going to mean in terms of
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