Most Canadians now recognize how helpful it is to have a registered Retirement Savings Plan (RSP) for retirement savings and other long-term goals. This year, consumers also have a new registered savings option to invest in — the Tax-Free Savings Account (TFSA).
You may be wondering whether you should still contribute to your RSP, open a TFSA instead or invest in both. The answer depends entirely on your personal investment goals and what you are saving for.
How RSPs and TFSAs compare
Both types of accounts can hold any type of investment — savings deposits, GICs, mutual funds, stocks and bonds. And both allow you to carry forward unused contribution room.
But there are some important differences between these two savings options that may influence how and when you might use each one.
An RSP, for example, is primarily intended to help you save for the long-term goal of retirement, though you can also use money in an RSP to buy your first home or to fund full-time continuing education, with certain limitations. A TFSA, on the other hand, can be used for either long- or short-term savings goals to save for multiple purposes — a trip, a car, home renovations, retirement and more.
Here’s a snapshot of the key differences between the two. However, it’s important to speak to an RBC advisor, who will work with you to create an investment plan based on your goals:
|
| RSP
| TFSA
|
| New contribution room created each year |
18% of previous year’s earned income, less any pension adjustment, up to the maximum annual RSP contribution limit for the year |
$5,000, beginning at age 18* |
| Carry-forward of unused contribution room |
Unused contribution room carried forward until the year in which you turn age 71 |
Unused contribution room carried forward indefinitely |
| Need earned income to contribute? |
Yes |
No |
| Ability to make contributions |
Until the end of the year in which you turn 71 |
No maximum age |
| Are contributions tax-deductible? |
Yes; they reduce taxable income |
No |
| Do savings grow tax-free or tax-deferred? |
Tax-deferred (not taxed until funds are withdrawn) |
Tax-free (never taxed) |
| Tax implications of withdrawals |
Withdrawals are added to your earned income in the same year the funds are withdrawn |
Withdrawals are tax-free |
| Can I withdraw savings for any reason? |
Yes, although the amount of the withdrawal is considered earned income and taxes are withheld at the time of the withdrawal (unless participating in the Home Buyer’s Plan or Lifelong Learning Plan) |
Yes, at any time (depending on what you invest in) |
| Do withdrawals affect contribution room? |
No, as contributions are based on previous year’s earned income |
Amount of withdrawals is added to contribution room starting the following calendar year |
| Do withdrawals affect government benefits? |
Withdrawals could affect eligibility for income-tested government benefits and tax credits since withdrawals are considered taxable income |
Income earned and withdrawals will not affect eligibility for income-tested federal government benefits and tax credits |
| Are there over-contribution penalty taxes? |
Yes; excess contributions are subject to a penalty tax of 1% per month on the amount that’s been over contributed. Penalty tax applies only if you exceed the $2,000 lifetime over-contribution amount |
Yes; excess contributions are subject to a penalty tax of 1% per month on the amount that’s been over contributed. |
| Am I required to convert my plan at a certain age? |
Yes — you must convert an RSP to a maturity option such as a RIF or an annuity by the end of the year you turn age 71, or you can choose to close the plan |
No |
The bottom line
RSPs remain the most powerful way to save for retirement, thanks to the fact that they provide an immediate tax benefit by reducing that year’s taxable income dollar for dollar.
This in turn reduces the amount of tax you have to pay — and could result in a tax refund. RSPs may also have a much larger annual contribution limit, which means they have the potential to accumulate a much larger nest egg than TFSAs alone could.
Think of the TFSA as a way to supplement your retirement savings by allowing you to save even more, and an opportunity to open another account that allows you to accumulate earnings tax-free. Their flexibility also makes them a convenient option if you need to draw on your savings prior to retirement, because you can withdraw money without penalty and re-deposit the funds at any time, if you wish, while leaving your RSP intact. Talk to an RBC advisor to figure out the best way to meet your needs.
Smart saving strategies
Here are some ways that you can use these financial tools in your long-term savings plan.
Your situation: You haven’t yet made any RSP contribution for the 2008 tax year, or you haven’t made your full contribution.
Your strategy: Focus on depositing as much to your RSP as you can before the March 2, 2009, deadline, as this should be your number-one priority. If you receive an income tax refund, use it to open a TFSA. While you’re at it, get a head start on next year’s RSP contribution by setting up a regular automatic savings plan. Saving for retirement will be much easier, and you’ll avoid the last-minute panic.
Your situation: You’ve already used up all your RSP contribution room for 2008 and all previous years.
Your strategy: Open a TFSA, and channel this year’s savings beyond your RSP limit toward making the maximum TFSA contribution. Continue to use your TFSA in future years to make additional savings after you’ve reached your RSP limit. You can also set up regular automatic contributions using a TFSA-Matic™.
Your situation: You have considerably more income and pay more taxes than your spouse.
Your strategy: Open or contribute to a spousal RSP to equalize the short- and long-term tax burden. You can also give money to your spouse to make his or her annual TFSA contribution for additional income-splitting opportunities.
Speak to your RBC advisor about the best way to use RSPs and TFSAs to meet your particular savings goals.
*The age of majority is 19 in certain provinces and territories, which may delay the opening of a TFSA. However, you start to accumulate TFSA contribution room at age 18.
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