Whether you’re a newcomer to Canada or just starting to dive into all things finance, this article will cover all you need to know about TFSA and RRSP accounts in Canada. 

‍TFSA

A Tax-Free Savings Account (TFSA) is a savings account that allows Canadian residents to earn tax-free investment income. Overall in Canada, you pay tax on any kind of income. Investment income or interest income is no exception, it is subject to Capital Gain Tax, and the purpose of TFSA is to shelter you from that tax. Any Canadian resident, 18 years old or older with a valid SIN number can open a TFSA account for free. 

How does TFSA work?

Contributions to a TFSA are not tax-deductible, which means you earn your salary, pay tax on it and put money in a TFSA. However, any income earned in the account, including interest, dividends, and capital gains, is not subject to taxes. TFSA account is also flexible, so you can withdraw money from your TFSA at any time, for any reason, without paying any taxes on your withdrawals.

For example, you have 10,000 dollars in your regular investment account, and let's assume you decide to invest in the stock market, make some trades, and end up with 11,000 dollars in your TFSA thanks to the stocks going up. Normally, you’d be required to pay capital gains tax on 50% of the 1000 dollars you have made or 500 dollars - that’s how the capital gains tax works, it taxes you on half of that gain, and the 500 dollars is then added to your total personal income in that year and is taxed according to your tax bracket. 

Whereas, if you hold your investments in the TFSA account, and you make the same 1000 dollars in investments, you will not pay tax on that amount - as long as that investment income is generated through your TFSA account. This is true, even if you decide to withdraw that money at some point. Hence, the name speaks for itself - a tax-free savings account.

Contribution limit

The TFSA was introduced in Canada in 2009, and since then, it has become a popular way for Canadians to save for their future. Contributions to a TFSA are limited by the government, and these limits are adjusted each year. For instance, the annual TFSA contribution limit for 2023 is $6,500. This means that you can contribute up to $6,500 to your TFSA in 2023. Any unused contribution room can be carried forward to future years, so the following year you can put in a larger amount.

The yearly countdown for the contribution room started from its inception in 2009. So if you’ve been in Canada since 2009 and were 18 or more in that year, you will have had roughly 5000 dollars or more of contribution room consistently added to you each year. Since its inception, each Canadian in 2023 has accumulated $88,000 of contribution room. That’s regardless of whether or not you had the account open, if you open the account today you will be able to add as much as you want within the given year until you max out the 88 thousand.

What happens if you exceed TFSA contribution room?

At any time in the year, if you contribute more than your available TFSA contribution room you will have to pay a tax equal to 1% of the highest excess TFSA amount in the month, for each month that the excess amount stays in your account. So if you do end up in a situation like this - just transfer the money out, and make sure to stick to your contribution limit.

You can always check your contribution room on the CRA website in your personal account.

‍

Benefits of TFSA

One of the key benefits of a TFSA is that it allows you to save money for a variety of goals, such as saving for a down payment on a house, a car, or a vacation. TFSA also provides flexibility, because you can withdraw money from your account at any time without penalty. This makes it a good choice for emergency savings or for short-term goals.

To sum it up, TFSA is a tax-free savings account that allows Canadian residents to earn tax-free investment income. Contributions to a TFSA are not tax-deductible, but any income earned in the account is tax-free.

‍

RRSP

A Registered Retirement Savings Plan (RRSP) is a tax-deferred savings plan, that is designed to help Canadians save for retirement. Contributions to an RRSP are tax-deductible, which means that you can claim a tax credit for the money you contribute to your RRSP. This can help reduce your taxable income and save you money on your taxes.

Opening an RRSP account is also free. Any Canadian resident that has employment income, files a tax return with the Canadian Revenue Agency (CRA) and is not yet 71 years old, is eligible to open an RRSP.

How does RRSP work?

For instance, if you are making 100,000 dollars in a given year in Ontario, your average tax rate will be 26.88%, meaning you will pay 26,880 dollars in tax. If you decide to make contributions to an RRSP account within that same year and put 20,000 dollars in the RRSP, this amount will be deducted from your total taxable income, so your taxable income becomes 80,000 dollars after the RRSP contribution. This event lowers your average tax rate to 25.52%, in this case your expected tax paid is 20,414 dollars. This means that putting 20,000 dollars aside in your RRSP delays the income tax you pay on that portion of income to the future, and lowers your current tax paid - so you get a nice tax refund from the government in the following year when you do your taxes.

The money you put into such an account is the money you’re not supposed to withdraw until your retirement, which is currently set to 65 years old. So once you reach your retirement age, you can start withdrawing money from your RRSP.

RRSP Contribution Limit

Similarly to TFSA, the RRSP account also has its own contribution limits, but it’s calculated differently. The amount which you can contribute to RRSP depends on your annual income - it’s 18% of your previous year’s income up to a maximum amount set by the CRA. In 2023 that limit is set to 30,780 dollars.

For example, you made $100,000 last year, which means that your contribution room for RRSP this year is 18,000 dollars - 18%. If your income goes up to 130,000 dollars next year, then your following year’s contribution room will increase by 23,400 dollars (18%) and so on and so forth. 

Any unused contribution room can be carried forward to future years, similarly to how TFSA works.

What this means for newcomers is you must have worked and filed your annual tax report first in order to be able to open RRSP and start contributing to it the following year.

Benefits of RRSP

The money you contribute to your RRSP can be invested, and the returns on these investments can help to grow your savings over time. This can be your additional source of income, outside your pension when you stop working and enter retirement age.

RRSP for Homebuyers

Another benefit of RRSP is a first-time homebuyer program that is essentially an additional source of savings for your down payment to buy your first home. Under the Home Buyers' Plan (HBP), you can withdraw up to $35,000 dollars tax-free from your RRSP to help finance the purchase of your first home, any amount higher than that will be taxed as your personal income. Once you withdraw the money from your RRSP under the HBP, that amount must be repaid to your RRSP over a period of 15 years.

‍

Difference between TFSA and RRSP

‍1. Flexibility

Generally, TFSA is a shorter-term savings account than RRSP. It’s more flexible - you can deposit and withdraw the money at any point in time with no penalties. Whereas, when you deposit your money into RRSP, you are not expected to touch it until you retire, or buy a home.

‍

2. Impact on taxable income

All TFSA contributions have no tax implications, but it is sheltered from tax on the investment gains generated from them, while RRSP helps you reduce your taxable income.

This means that with an RRSP, you can save on your taxes now and pay taxes on your withdrawals later, while with a TFSA, you pay taxes on your contributions now and can make tax-free withdrawals later.

You can also find other differences in our graph.

‍

‍

Should you open TFSA and RRSP?

Absolutely yes, you should open both TFSA and RRSP and start contributing to them as soon as you can. Opening these accounts is absolutely free, you can do it with any bank.

If you are looking to reduce your taxable income in a given period and don’t have a burning need for money, RRSP is something you should definitely prioritize first. Even if you’re not looking to reduce your taxable income, but want to build a comfortable financial future for your retirement, we highly recommend you start contributing to your RRSP account. 

Open up an RRSP, set it up as an investment account, buy some index funds and see your wealth grow over the years. There are companies and banks that can manage your investments inside RRSP for a small fee if you’re uncomfortable managing it yourself. It’s totally worth it, this is passive income, money will be making money while you sleep. One day you’ll wake up and see a nice sum accumulated in your RRSP to provide you with a comfortable retirement.

TFSA is great for saving and investing, you can have an interest-based TFSA account open where you just earn interest on your deposits. You can also open an investment TFSA account, in which you can purchase stocks, ETFs etc. You will not be taxed on the returns made in this account and will be able to withdraw the money at any point in time if something happens. TFSA provides a great level of flexibility here, there’s absolutely no reason not to open it today and start using it!

‍

What is the next step?

If you are ready to open a TFSA or RRSP, we’d recommend starting with Wealthsimple - it’s an investment management service that makes it super easy for a novice investor to set everything up.

You can set up an investment account with both TFSA and RRSP and start saving and investing on your own terms. 

They also have really cool features, for example, the “roundup feature”, where every purchase you make with your credit card is rounded up to the nearest dollar, and that rounded-up amount goes into your saving account automatically. It’s the easiest way to start saving! 

We hope this information was helpful for you and you will use this knowledge to build your successful financial future in Canada! Good luck!

‍