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Scotia Wealth Management

Three reasons why you should maximize your TFSA and RRSP savings plans

February 11, 2019

When you are thinking about maximizing your savings, one thing to keep in mind are simple ways to minimize income tax and capital gains tax. Fortunately, there are two savings vehicles designed specifically for this purpose: Registered Retirement Savings Plan (RRSP) and Tax-Free Savings Account (TFSA).

Both of these plans should be a prominent part of your retirement or savings strategy. An RRSP is primarily used to save for retirement while a TFSA can be used for a variety of purposes, including supplementing retirement income, saving for a home or achieving other saving goals.

Here are three reasons why you should maximize your savings in these plans:

1. Tax advantage

For both a TFSA and RRSP, any income you earn from growth of the assets in the plan is tax free while it is in the account. That means you won’t face a capital gains tax or income tax on interest earned, or dividends received. For example, if your investment grows from $5000 to $10,000 while paying you an annual dividend, you will not pay tax on the capital gain of $5,000 or the income from the dividend.

An RRSP carries another added benefit – whatever amount you invest in an RRSP each year (subject to limits explained below) is deducted from your taxable income for that year. Of course, that also means that when you take the money out of the RRSP, it will be considered income and taxed. This feature is a main side effect of the RRSP being designed to promote retirement savings. The idea is that you will withdraw the funds when you are retired and most likely at a lower tax rate than during your prime earning years.

With a TFSA, you are investing after-tax income, so you can’t claim contributions as a deduction against your income. The upside is that because you have already paid the taxes, you can withdraw funds from a TFSA at any time without being taxed. That’s why a TFSA can be a good option to save money for a house or major purchase – you can withdraw the funds anytime without a tax hit.

2. Carry forward contribution room

There are annual limits on what you can contribute to a TFSA or RRSP, but if you are not able to make the maximum allowable contribution, or if you have not made contributions at all up to this point, you can carry that contribution room forward. (See examples below.)

Keep in mind that the rules are different for contributions. In a TFSA, you can withdraw your savings tax-free and re-contribute what you withdraw in the following calendar year without taxes or penalties. However, an RRSP is different. If you withdraw funds from your RRSP, three things happen: 1) the withdrawal counts as income for that year, 2) the withdrawal amount will be subject to income taxes, and 3) you will not be able to recontribute that amount the next year.

3. Flexibility of investments and tax-free compounding

Both plans offer flexibility to invest in a wide range of investment vehicles such as GICs, bonds and stocks, which allow you to achieve higher growth than if you leave the funds in a low interest savings account. Also, profits and income accrued in your RRSP from those investments can be realized and reinvested tax free.

Here’s a quick comparison of the major features:

TFSA contributions limit:

For 2019, the government has increased the TFSA contribution limit from $5,500 to $6,000. That means that if you have never contributed to a TFSA and were over the age of 18 in 2009, the maximum TFSA contribution room for 2019 is $63,500.

RRSP contribution limit:

RRSP contribution limits for a given year are calculated by taking into account your earned income each year and limits set by the government. So, in 2018, your contribution limit will be the lesser of the following:

  • 18% of your earned income from the previous tax year. (Earned income includes self-employed net income, CPP/QPP disability payments and net rental income.)

OR

  • The maximum annual contribution limit for 2018 of $26,230 minus any company-sponsored pension plan contributions (defined as PA, short for Pension Adjustment on your T4 slip).

Note: you are able to make contributions to your RRSP that will count against your 2018 income until March 1, 2019. Also, be sure to check on your unused RRSP contribution room from previous years, which can be found on your previous year’s tax return or by contacting Canada Revenue Agency.

Is one plan superior to the other?

Both plans are advantageous for different reasons. If you have the ability to save and maximize both plans, that is definitely the best option. If you can only invest in one of them, determining the best choice for you will require an assessment of your financial situation and savings objectives.

If you have questions about your TFSA or RRSP or want to discuss them further, please contact us anytime.

New Podcast Release: Check out this week’s new podcast, “Raising Kids and Retiring Responsibly” in which Richard interviews Ron and Anne. In this episode, Anne and Ron discuss how diving headfirst into work at a young age taught them financial responsibility. Listen here.

 

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This publication has been prepared by Scotia Capital Inc. and is intended as a general source of information only and should not be considered as personal and/or specific financial, tax, pension, legal or investment advice. We are not tax or legal advisors and we recommend that individuals consult with their qualified advisors before taking any action based upon the information contained in this publication. Opinions and projections contained in this publication are our own as of the date hereof and are subject to change without notice. While care and attention has been taken to ensure the accuracy and reliability of the material in this publication, neither Scotia Capital Inc. nor any of its affiliates make any representations or warranties, express or implied, as to the accuracy or completeness of such material and disclaim any liability resulting from any direct or consequential loss arising from any use of this publication or the information contained herein. This publication and all the information, opinions and conclusions contained herein are protected by copyright. This publication may not be reproduced in whole or in part without the prior express consent of Scotia Capital Inc.