RRSPs and TFSAs: What they are
RRSPs and TFSAs are plans that allow you to hold various types of investments, such as mutual fundsA mutual fund is made up of money that is pooled by several investors and used on their behalf by a manager to buy shares, bonds or other securities in line with the fund’s objectives. , exchange-traded fundsAn exchange-traded fund (ETF) is an investment fund whose securities are traded on an exchange like shares.
These funds generally track a benchmark index. Unlike a mutual fund manager, an ETF manager does not seek to maximize the fund’s return but only to follow an index; this explains the typically lower management fees for ETFs. (ETFs), sharesA share, also referred to as stock, is an equity security that entitles you to an ownership interest in a company.
The company can distribute a portion of its earnings to shareholders by paying them a dividend.
The shares of companies listed on an exchange are bought and sold at the exchange.
When a company ceases to operate, the proceeds from the sale of its assets are used to pay its debts and taxes, and the rest of the money is distributed to shareholders., bondsA bond is a security issued by governments and companies through which an investor lends money to the issuer.
In general, the government or company promises to pay the investor interest at a fixed rate and at certain intervals (for example, 2% per year). Interest is normally paid twice a year. At maturity, the government or company pays back a predetermined amount that is called the face value. The face value is usually $1,000.
There are several types of bonds:
Stripped bondReal return bondConvertible bondSavings bondRetractable bondUnsecured bondEtc. , and guaranteed investment certificatesA guaranteed investment certificate (GIC), also called a certificate of deposit or term deposit, is a security indicating that an investor has lent money to a financial institution. GICs earn interest. (GICs).
Although you’ll save tax with both plans, they’re different in a number of ways.
RRSP
An RRSP (Registered Retirement Savings Plan) lets you build up savings that are taxed only when you withdraw them—usually when you retire. The return on your RRSP contributions is tax-free (normally, you must pay tax on investment income).
Better yet, contributions to an RRSP will reduce your taxable income.
REMEMBER! You’ll only get a tax deduction if you’ve earned enough income to pay tax. That may not be the case if you’re a student. If, however, you take money out of your RRSP, the withdrawals are added to your taxable income, in which case you would pay the applicable tax.
End of the warningTFSA
A TFSA (Tax-Free Savings Account) is a savings plan that allows you to grow TFSA contributions tax-free. On one hand, TFSA contributions are not tax deductible. On the other hand, you don’t pay tax when you withdraw amounts from your TFSA.
REMEMBER! You must be 18 and over to contribute to a TFSA.
End of the warningHere are the main differences you need to know to understand RRSPs and TFSAs
| RRSP | TFSA | |
|---|---|---|
| Flexibility | Generally, the amounts you withdraw cannot be replaced. | You can withdraw amounts and replace them the following year. |
| Tax | When you contribute, you can obtain a tax deduction (if you pay tax). However, the money in your RRSP will be taxed as part of your taxable income if you withdraw it. | You can withdraw amounts without paying tax. |
| To buy a first home | You can take out amounts tax-free to buy or build a first home (Home Buyers’ Plan), but you’ll have to pay these amounts back into your RRSP in the years following the withdrawal. | You can withdraw amounts without paying tax. |