Canadians have options when it comes to retirement savings. The Registered Retirement Savings Plan (RRSP) has been the standard since 1957, when it was first established to encourage saving for retirement. In 2009, however, a new retirement savings plan – the Tax-Free Savings Account (TFSA), introduced by Jim Flaherty, Canadian federal minister of finance – went into effect, providing Canadians with another powerful savings method. While the goal of both the RRSP and the TFSA is the same – to help Canadians save money – each is a unique savings vehicle with plan-specific advantages. (To learn more, see our tutorial: Registered Retirement Savings Plans.)

The Tax-Free Savings Account

Canadian residents who are age 18 or older can contribute up to $5,500 each year to a Tax-Free Savings Account. Contributions are not deductible for income tax purposes, but TFSA savings can be withdrawn tax-free at any time and for any reason. A TFSA can hold a variety of investment instruments, including cash, stocks, bonds and mutual funds, all of which can grow tax-free for life. That means that interest, dividends and capital gains earned in a TFSA are never taxed, even when they are withdrawn.

Since the savings in a TFSA can be withdrawn at any time and for any reason, these plans are frequently used to save for purchases, such as automobiles, homes or even vacations. In addition, any money that is withdrawn can be put back into the plan during the following calendar year. (To learn more, see Tax-Free Accounts Make Saving a Snap for Canadians.)

The Registered Retirement Savings Plan

Canadian taxpayers each year can contribute up to 18% of the previous year's earned income plus any unused contributions from previous years to a Registered Retirement Savings Plan – up to the yearly maximum contribution limit ($26,010 for 2017). Contributions are tax deductible, and earnings grow tax-free inside the plan; however, withdrawals are taxed. (The exceptions: withdrawals to buy a first home or to help pay for your or your spouse's education are not taxed; in both cases, you pay the money back over time.) Since withdrawals are typically made during retirement and when participants are earning less money, it is likely that lower tax brackets will apply, resulting in less tax liability. Like TFSAs, RRSPs can hold a variety of assets, including cash, guaranteed investment certificates (GICs), mutual funds, stocks and foreign currency.

Because RRSPs are tax-deferred savings vehicles, these plans are ideal for taxpayers who expect to have a higher tax rate when the money is put into the plan versus when they will take money out of the plan. Figure 1 compares the basic features of TFSA and RRSP plans.

Figure 1: A comparison of the basic features of two popular Canadian retirement savings plans, the Registered Retirement Savings Plan and the Tax-Free Savings Account.

RRSP

TFSA

Minimum Age

No minimum age as long as there is earned income

18

Maximum Age

Must cash out, convert to a Registered Retirement Income Fund (RRIF) or purchase an annuity by December 31st of the year the participant turns 71

No maximum age

Tax Deductible Contributions

Yes

No

Tax-Free Accumulation

Yes

Yes

Tax-Free Withdrawals

No

Yes

Contribution Limit

18% of earned income from the previous tax year or $26,010 (whichever is less)

$5,500

Withdrawals Make Room for Contributions

No

Yes, during the following calendar year only

Allowable Investments

Stocks, bonds, mutual funds, index funds, ETFs, GICs, savings accounts

Stocks, bonds, mutual funds, index funds, ETFs, GICs, savings accounts

The Bottom Line

Both RRSPs and TFSAs offer Canadians a powerful means of saving for retirement. The Registered Retirement Savings Plan, which has been around for 60 years, provides an upfront tax incentive, since contributions are tax deductible. Withdrawals made during lower-earning years generally result in reduced tax liability. Tax-Free Savings Accounts, on the other hand, offer no upfront tax incentive, but since withdrawals can be made at any time tax-free, they provide a practical means of savings for retirement or short-term purchases. Canadians are not limited to choosing one plan over the other, and many opt for both plans to meet their savings and retirement goals.

You may also be interested in 5 Retirement Questions Everyone Must Answer and What are the differences between a Registered Retirement Savings Plan (RRSP) and a Registered Pension Plan (RPP)?)

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