We get a lot of questions year round on RRSP’s and TFSA’s- and often our clients aren’t quite sure the difference between the two. Understandable!
We recently came across this article posted by CPA BC, and it breaks it down quite simply:
Know the difference between a RRSP and a TFSA
The RRSP is a government-registered retirement savings plan that you open at a financial institution such as a bank or wealth management firm, and to which you and your spouse/common-law partner can make contributions. RRSP contributions can be used as deductions to reduce your tax annually. Any income you earn in your RRSP is usually tax exempt, if the funds remain in the plan, but you will have to pay tax when you make withdrawals (with some exceptions, such as buying your first home).
Put simply, a RRSP is a tax-deferring vehicle. The key concept here is that your income tax rate should be lower when you retire than when you are working. Therefore, you are better off seeking the benefits of the tax reduction now and paying it in retirement when your income and tax rate is typically lower.
Many are confused about the Tax-Free Savings Account, TFSA, and its purpose. The TFSA began in 2009 as a way for Canadians 18 and older to set money aside tax-free throughout their lifetime. But the TFSA isn’t just a savings account. Treat your TFSA as an investment vehicle instead. Any amount contributed and any income earned in the account, such as investment income and capital gains, is generally tax-free, even when it is withdrawn.
Remember, your RRSP contribution looks backwards and it is calculated based on your previous year’s income. Your TFSA is based on a go-forward basis, but both are cumulative. The difference between the two is how you are taxed (or not taxed) when you eventually access your funds.
The deadline to contribute to your RRSP for the 2020 tax year is March 1, 2021. Make sure to contact us with any questions prior to this deadline.
RRSP and TFSA: 4 things every Canadian should know about by Jeff Brown