TFSA versus RRSP – Ashley chooses both

TFSA versus RRSP – Ashley chooses both

A couple of weeks ago our writer Ashley started investing in a TFSA (Tax-Free Savings Account). She gave up her monthly magazine addiction to be able to contribute $100 monthly towards a down payment, on top of a $2000 lump-sum deposit. Her fiancé also started his own investment plan, contributing $200 monthly on top of a $5000 lump-sum deposit to a TFSA. Both of them also contribute to RRSP, but a lesser amount. Already they have $7000 towards a down payment.

The Tax-Free Savings Account (TFSA) is a flexible, registered, general-purpose savings vehicle that allows Canadians to earn tax-free investment income to more easily meet lifetime savings needs. The TFSA  is intended to complement existing registered savings plans like the Registered Retirement Savings Plans (RRSP) and the Registered Education Savings Plans (RESP). 
How the Tax-Free Savings Account Works

  • As of January 1, 2013, Canadian residents, age 18 and older, can contribute up to $5,500 annually to a TFSA. This is an increase from the annual contribution limit of $5,000 for 2009 through 2012 and reflects indexation to inflation.
  • Investment income earned in a TFSA is tax-free.
  • Withdrawals from a TFSA are tax-free.
  • Unused TFSA contribution room is carried forward and accumulates in future years.
  • Full amount of withdrawals can be put back into the TFSA in future years. Re-contributing in the same year may result in an over-contribution amount which would be subject to a penalty tax.
  • Choose from a wide range of investment options such as mutual funds, Guaranteed Investment Certificates (GICs) and bonds.
  • Contributions are not tax-deductible.
  • Neither income earned within a TFSA nor withdrawals from it affect eligibility for federal income-tested benefits and credits, such as Old Age Security, the Guaranteed Income Supplement, and the Canada Child Tax Benefit.
  • Funds can be given to a spouse or common-law partner for them to invest in their TFSA.
  • TFSA assets can generally be transferred to a spouse or common-law partner upon death.

What are some of the differences between a TFSA and an RRSP?

  • An RRSP is primarily intended for retirement savings. Tax assistance provided by a TFSA complements that provided through RRSPs.
  • RRSP contributions are tax-deductible while RRSP withdrawals are added to income and taxed at regular rates.
  • TFSA contributions are not tax-deductible but the contributions and the investment earnings are exempt from tax upon withdrawal.
  • Unlike an RRSP, which must be converted to a retirement income vehicle at age 71, a TFSA does not have any minimum withdrawal requirement.
  • There is no TFSA spousal plan. Individuals can provide funds to their spouse or common-law partner to invest in their TFSA, up to the spouse’s or common-law partner’s available room, and the income earned on the contributed amount is generally not attributed back to the spouse or partner who provided the funds.
Like Ashley, consider consulting your bank, credit union or other financial service provider before deciding whether to place money in an RRSP or a TFSA or to find out the combination of contributions that is best for your situation.
Information gathered from http://www.tfsa.gc.ca/.

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