RRSPs (Registered Retirement Savings Plans) and TFSAs (Tax-Free Savings Accounts) are products designed as incentives to save. These accounts act as containers for your investments and, inside them, your money can grow and accumulate tax-free. Each account type works a little differently.
RRSPs are a tax deferral program. You'll pay tax on your savings when you withdraw them in retirement. The idea is that you'll be in a lower marginal tax bracket in retirement than you are in your working years. However, that is not always the case. Other benefits include getting immediate tax relief by deducting your RRSP contributions from your income each year and not having to pay tax on the money you make on your RRSP investments.
“If you are in a lower tax bracket now, you may not see those savings when you go to retire,” said Stacey Vanhove, lead Wealth Management Advisor at Sunrise Credit Union. “You can save the RSP room for when you’re in a higher tax bracket in your 30s and 40s, hopefully.”
There are limits on how much you can contribute to an RRSP each year. It is 18% of your earned income in the previous year, or the maximum contribution amount for the current tax year ($26,500 for 2019). If you don't have money to contribute in a year, you can carry forward your RRSP contribution room and use it in the future.
For the 2020 taxation year, the RRSP contribution limit would be a maximum of $27,230, and for the 2021 taxation year, the RRSP contribution limit is $27,830.
You can carry forward the RRSP contribution room that you cannot use in any particular year indefinitely - well, at least until you turn 71 years of age and can no longer have an RRSP account.
The value of your RRSP may go down as well as up, depending on the investments it holds. You can open an RRSP at any age as long as you have earned income and file a tax return. You must close your RRSP when your turn 71, withdraw your savings in cash, convert your RRSP to an RRIP (Registered Retirement Income Fund) or buy an annuity.
TFSAs are not strictly for retirement savings – you can also use them for any savings goal. TFSAs are flexible, as withdrawals can be made at any time and are tax-free because you made the contributions with after-tax dollars. You can continue contributing to a TFSA at any age and cannot deduct contributions from your income tax return.
“Younger people are using it more for shorter-term savings where just a normal savings account would be sufficient,” said Vanhove, “They don’t have enough assets to be taxed on the interest they’re earning in that savings account yet. With a tax-free savings account, you want your better-performing investments in, and also, it’s a longer-term.”
The TFSA contribution limit for 2020 was $6,000, and it will remain the same for 2021. $75,000 is the total room available in 2021 for someone who has never contributed to a TFSA since its introduction in 2009.
There are many details in either a TFSA or an RSP. Your financial advisor can help you and your family navigate through them to find the best solution for your situation.
Bruce Luebke, Communications and Content Coordinator, Sunrise Credit Union