A new year is underway, and that means there is another year’s worth of financial decisions to make. With a new year comes new information, and some opportunities to be a wise manager of your money. In our last post before the holiday season, we looked at new information that the CRA had released. This included the likes of TFSA contribution room, RRSP Maximums, and changes to CPP. Here, we are going to look at the TFSA and RRSP, and outline their core advantages. Hopefully, this will help you decide which you should be contributing to in 2021.

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TFSA Basics

In most circumstances, the TFSA is the best available investment vehicle. It was introduced in 2009 and is available to anyone with a valid social insurance number who is age 18 or older. Each year since its inception CRA has allotted more contribution room. The maximum that any one can contribute is $75,500. In order to contribute that much, you must have been 18 or older in 2009.

Here is a great chart to show you how much you can contribute based on you year of birth:

Rather than just taking our word for it, here are some examples of why the TFSA is so great.

Withdrawals can be Re-contributed

One of the best features of a TFSA is its built-in flexibility. Any funds that are withdrawn from a TFSA can be recontributed as of Jan 1 of the following year. The withdrawn funds do not have to be recontributed.

Contribution room is calculated as follows: Unused room from previous year + amounts withdrawn + new contribution room.

Let’s say your TFSA is worth $90k and you still have $10k of contribution room in 2020. At the end of 2020 you withdraw $70k. In 2021 your contribution room would be $10k +$70k + $6k.

Contributions/Withdrawals at Any Age or Time

As mentioned above the TFSA is arguably the most flexible investment account available. That flexibility means contributions or withdrawals can be done at anytime, and for any reason. Granted, this assumes that you still have contribution room available.

This may not sound like a big deal, but it is. For example with an RRSP, if you make a regular withdrawal, that income is taxable and you lose that contribution room. Furthermore, you want the RRSP contribution to be deductible for 2020 you have to make a contribution by March 1, 2021. There are other withdrawals available for an RRSP and we will talk about those later.

Because contributions and withdrawals are extremely flexible, the TFSA makes a great emergency savings vehicle. Furthermore, even upon your eventual demise, a TFSA is paid directly to the beneficiary tax-free or to your estate.

Investment Gains are Truly Tax-Free

Due to TFSA contributions being done with after-tax dollars, all funds grow completely tax-free. This means if your investments generate dividends, capital gains, interest, etc. and whether your realize that gain or not, it will not ever be taxed. Not now, not when it is withdrawn, and not even when you die.

This brings us to the next point.

TFSA Withdrawals Do Not Count as Income

Withdrawals from a TFSA, as noted above, are completely tax-free and are not classified as taxable income. However, withdrawals from an RRSP have a minimum amount of withholding tax levied at source and the withdrawal amount is added to your taxable income. 

Having withdrawals counted towards income is significant and should be carefully watched. During retirement when income surpasses a certain level, clawbacks are triggered on Old Age Security (OAS). Clawbacks to OAS in 2020 were triggered at the $79,054 income level. If net income was higher than $125,937, OAS is completely clawed back and reduced to zero.

Other means tested government programs will also not be affected by withdrawals from a TFSA. Other notable means tested programs include disability programs.

Note that there is an exception to the OAS clawback ceiling. For more information on that here is a great article written by one of our colleagues Aaron Hector: OAS Clawback Secrets for the High-Net-Worth.

Want to read more on TFSA’s? Check out the following:

• You Should Be Maxing Out Your TFSA
• Using a TFSA vs. Buying a Rental Property
• New Information on The TFSA, RRSP and CPP
• A Beginners Guide to The TFSA

RRSP Basics

The RRSP has been around a lot longer than the TFSA, and a lot more people are familiar with it. However, it is still widely misunderstood. We often advise people that if they are under the $90k income level, that TFSAs should be maxed out first. This is even more relevant for those who might not be making substantial money now, but believe they will make substantially more later on.

Following are the key factors that make RRSP a great savings vehicle.

Tax-Deductible Contributions

Contributions to an RRSP are made with pre-tax dollars. This means that money contributed is directed deductible from your taxable income. By lowering your taxable income, it decreases the amount of tax payable in that year.

Let’s say you make $105,000 in 2020. In early 2021, you make an RRSP contribution of $15,000. So rather than paying tax on the $105k, you would now be paying tax on $90k. Assuming you pay an average of 35% tax, your tax savings for 2020 would have been $5,250 ($15,000 * 35%).

An RRSP is a tax deferral tool. The money that is contributed can be invested and grows tax deferred. All funds withdrawn are added to your taxable income in the year of withdrawal. The goal of the RRSP is that when you withdraw funds in retirement, hopefully, you will be in a lower tax bracket than when you contributed those funds.

Spousal RRSPs

Another great benefit to RRSPs is the availability of Spousal RRSPs. The Sp. RRSP has the same tax-deferral benefit as a regular RRSP, however, with the added benefit of being able to split income with your spouse or common-law partner.

With Sp. RRSPs, the higher earning income spouse, assuming they have contribution room, makes a contribution to a Sp. RRSP in the name of the lower income earning spouse. This still allows the higher earning spouse claim the tax deduction. However, when those funds are withdrawn, they are taxed in the hands of the lower income spouse.

RRSP Homebuyers Plan

One great program that has been attached to the RRSP, is the Home Buyers Plan (HBP). The RRSP HBP allows you or a related person with a disability to withdraw up to $35,000 from your RRSP to buy or build a qualifying home.

Any funds that are withdrawn must be repaid with a 15 year period. Repayment starts in the second year after the year the funds were first withdrawn. No tax is withheld on the initial withdrawal. This makes it more beneficial than a regular RRSP withdrawal. However, if the HBP is not paid in the amount on the statement received from CRA for that year, that amount is added to your taxable income for that year. Furthermore, that contribution room is now lost.

The RRSP Home Buyers Plan is a great option for those that have a RRSP and qualify as a first-time homebuyer. Before going ahead with the HBP, make sure you discuss it with your financial planner. For more information check out RRSP Home Buyers Plan 101

RRSP Rollover

Another great benefit to the RRSP is the RRSP Rollovers. There are two rollovers to be aware of, the spousal rollover and the RDSP rollover. Proceeds in an RRSP are able to be rolled over to a spouse upon death. If a spouse is not designated as a beneficiary, the RRSP is liquidated and fully taxable as ordinary income in the year of death. However, if a spouse is still alive and designated as a beneficiary, the funds are rolled over to them and no tax has to be paid.

The second, but much more selective rollover, is only eligible to those with a disabled and financially dependent child or grandchild. This provision allows the funds from a retirement savings plan to be transferred on a tax-deferred basis to an RDSP. The funds that are rolled over are not eligible for matching grants. Furthermore, all funds rolled over reduce the amount of eligible contribution room. That being said, the most that could be rolled over is $200,000, assuming that no other contributions had been made.

To learn more about RDSPs read the article below:

• What You Should Know About The RDSP
• Using an RDSP: Case Study

For more information and other information that was touched on above regarding RRSPs, check out the following:

• RRSP Home Buyers Plan 101
• New Information on The TFSA, RRSP, and CPP
• RRSPs in 2020
• RRSP: When and Why You Need Them

Conclusion

TFSAs and RRSPs each have their strengths and situations where one is more beneficial than the other. The safest option if you’re deciding between the two is contributing to your TFSA. We say this because if down the road you realize you should have contributed to your RRSP you can move the funds over without any adverse tax consequences. However, doing the opposite, pulling funds from the RRSP and moving them to the TFSA will generate a tax bill. If you are not sure which you should be contributing to, sit down with your financial planner.

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