RRSPs and TFSAs — What’s the Difference and Why Should I Invest in Them?

As January is in full swing, we’ve all been making resolutions for this new year. A resolution is usually about doing something different in our routines to improve the coming year. A few small changes in January, however, can have a positive effect on your financial future and your past. We want to talk about Registered Retirement Savings Plans (RRSPs) and Tax-Free Savings Accounts (TFSAs).

What Are TFSAs and RRSPs?

TFSAs and RRSPs are savings accounts that you can use to save and plan for your future. They have a few things in common, such as having contribution limits and sheltering your investment from taxes while in the account, but they also have many differences, making them perfect for specific uses and goals.

What Are Some of the Differences Between RRSPs and TFSAs?

An RRSP is a savings account that’s specifically tailored to help you save for retirement or other long-term goals. All contributions to an RRSP must come from earned income, but other than that, there’s no limit to how early you can open the account. A TFSA, on the other hand, cannot be opened until you turn 18. With an RRSP, you can only hold the account until you turn 71, whereas a TFSA has no age limit, and you can continue to invest in it for as long as you like.

The key difference between an RRSP and a TFSA is how they’re taxed. RRSPs are tax-deductible, meaning you can deduct the amount you put away from your previous year’s income during tax season. This can help you pay fewer taxes on your investments as, in theory, you’ll be removing the funds from your RRSP in retirement when your income is lower and, thus, your tax bracket is, too. When you remove the money from an RRSP at a lower income tax bracket, you pay less in taxes. With a TFSA, you’ve already paid the taxes on the money that you’ve put in the account. So, when you withdraw from a TFSA, you don’t need to pay taxes again. This setup makes TFSA accounts perfect for shorter-term goals since withdrawing from the account will not affect your annual income.

We mentioned that both TFSAs and RRSPs have contribution limits, and they each handle contribution limits in a unique way. With a TFSA, you have a limit that’s chosen each year. For 2017, the maximum contribution limit is listed as $5500. That’s not a black-and-white limit, though. Your limit is determined by the posted limit for the year, plus any unused contribution room from the previous year, plus any withdrawals you made from the previous year. An RRSP, however, has a limit of either 18% of your earned income or the posted limit for the year, which was $26,010 for 2017.

When Should I Invest in an RRSP or TFSA?

The earlier, the better, thanks to compound interest. If you were to invest in your RRSP or TFSA at the beginning of the year rather than the end, you’d be making interest on this deposit all year. That’s not the only advantage for RRSPs, either. By making sure you start the year off strong, you’ll also have that deposit to file against your income tax for the previous year. It’s a win-win. Planning for your future retirement income and keeping your wealth management plan in mind at the beginning of the year not only sets you up for future success but it’s also a great benefit when it comes to your previous year’s income during tax season.

Wealth management and retirement savings can be a hard topic to master and understand no matter what situation you’re in. For example, an RRSP is only really valuable if your retirement income will be lower than your current income. That way, you pay fewer taxes on the amount you put away while your income is higher. Planning for your financial future can get overwhelming — fast — when you think about your goals, your timeline, all the resources available to you, and what your income will even allow. We’d love to help take some of the fear and confusion out of your financial planning and help you to start the year off strong. Jordan’s here to help answer your questions. Send Jordan an e-mail today and make 2019 a great year.