TFSA? RRSP? What do I do with all my money?
The following is a guest post by Mr. OYP who will be posting on this site from time to time.
Here in Canada, we have two great options available to us to save for our futures / retirements. These savings vehicles are the TFSA (Tax Free Savings Account) and the RRSP (Registered Retirement Savings Plan).
I want to simply give you an overview of these two savings vehicles and will write a later article on the pros and cons of each to help you decide which is better for you during different stages of your life.
TFSA
The TFSA was first introduced in 2009. Once you are 18, you can contribute to the TFSA. For the years 2009 – 2012, you could contribute $5,000 per year into this account. In 2013 – 2014, the limit was $5,500. It went up to $10,000 in 2015, and has been $5,500 per year since then. If you were 18 as of the TFSA’s inception, you have up to $57,500 in contribution room at this point! The contribution room does not disappear if it is not used.
In your TFSA, you can hold a number of different types of investments (i.e. GICs, which stands for guaranteed investment certificates, high interest savings accounts, stocks, bonds, ETFs, which stands for exchange traded funds, etc.). I highly recommend looking at your TFSA as more of a tax free investment / retirement account holding equities (i.e. stocks and/or ETFs) instead of as a short term high interest account (high interest savings accounts typically provide less than 1% these days – not even keeping up with inflation, so you are essentially losing money). If you hold equities (stocks, ETFs) in your TFSA and do not withdraw for many years, you can take full advantage of the magic of compound interest and watch your TFSA grow into a sizeable nest egg by the time you are ready to retire.
The money you put into your TFSA is after tax income. As such, you do not get a tax refund on the money contributed into it because you have already paid taxes on this money.
Unlike the RRSP, you can take money out of your TFSA any time without penalty or having to pay taxes (as it is after tax money as mentioned above). However, as noted above, try to only withdraw from your TFSA as a last resort in order to allow that sweet compound interest to take effect.
Keep in mind, if you take money out of your TFSA, you may have to wait until the next year to put the money back in. This rule comes into play once you’ve maxed out your contribution room. For example, if you have maxed out your TFSA and you take out $5,000, you have to wait until the next calendar year to put that $5,000 back into your TFSA or else you would be subject to the TFSA overcontribution penalty.
RRSP
The RRSP has been around since 1957. Like the TFSA, you can hold a number of different types of investments in your RRSP. The money put into your RRSP is done with pre-tax income. This is why you get a tax refund when you contribute to your RRSP. You will get taxed on this money when you take it out in retirement, but you will hopefully be in a lower tax bracket in retirement and will have to pay less tax at that point.
Your maximum RRSP contribution is the lower of 18% of your gross income or $26,230 (in 2018). The unused contribution room can be carried forward to the next year. So, if you have unused room, you should contribute larger amounts in years when your income is high. This will lower your tax rate and you will be subject to a larger tax refund.
Keep in mind that if you withdraw from your RRSP before you retire, you will be subject to paying substantial taxes on the early withdrawals. Generally, the two exceptions to this are if you are withdrawing as a first time homebuyer, or if you use the withdrawal money to go back to school. However, these early withdrawals will have to be repaid later.
Final Recap
Both the TFSA and RRSP are great options for saving for your future. Treat these as retirement accounts and buy and hold equities for a long period of time in these accounts, and you’ll be set up well for your future!
Related articles:
For a brief overview of the stock market and investing for beginners, please check out this article. For 9 ways to take control of your finances in 2019 click here.
Ms. OYP paid off $98,500 in 3.5 years – find out how she did it:
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Please note that I am not a financial professional, so this is purely based on my own experience using the TFSA and RRSP options. Make sure to consult with a financial professional if you have questions.