What is an RRSP? What is a TFSA? What can they be used for?

A RRSP is a Registered Retirement Savings Plan and a TFSA is a Tax Free Savings Accounts. They are similar in some ways and quite different in others.

RRSP

A RRSP is a government developed mechanism that provides some benefits to the saver, encouraging them to save for retirement. Motivating the public to set aside the money to fund their retirement is in everyone’s best interests as the Canada Pension Plan (CPP) and Old Age Security (OAS) pension plans provide a nominal retirement income. Not enough for most to live on.

Each individual who has declared earned income is provided with a RRSP allowable contribution amount. This grows if you don’t use it all and there are annual maximums that you can attain. In a nut shell, a RRSP is a tax deferral vehicle. You receive income tax already paid back on RRSP contributions and while it’s invested in a RRSP, it grows tax sheltered but you pay tax on it when you withdraw it (based on the amount you withdraw). For example, if you pay tax at a rate of 25% and you invest $2,000, you will receive approximately $500 in a tax refund. You can choose which tax year to take the deduction.

Many, many types of investments are eligible for RRSP’s. The First Time Home Buyer’s Program also allows eligible Canadians to withdraw money without being taxed for purchase towards a home. There are rules and guidelines and to avoid paying tax on the withdrawal you must repay it according to the program rules. The other benefit to a RRSP is that it is there in the event of an emergency. It may not be a good time to withdraw it but if it’s a tough situation and you have no other resources…..

Another note about RRSP’s is that you can use your contribution room to invest on behalf of a spouse, building up retirement assets in both your names so that upon withdrawal you are taxed individually (theoretically at lower individual rates) rather than one person being subject to tax on a larger withdrawal.

TFSA

A TFSA is a Tax Free Savings Account. Another government program with incentives to motivate Canadians to save. Initiated a couple years ago, the general concept is that each Canadian over the age of 18 has $5,000 per year to invest in a TFSA and the earnings while growing in this investment vehicle are not taxed either while they’re invested or upon withdrawal. If you don’t use the annual allocation, it carries forward. If you withdraw funds, you can re-invest in the following calendar year without penalty. There are many types of investments that are TFSA eligible. A pretty good deal!