TFSA VS. RRSP-What's the Difference?
Canadians planning for retirement know that they have two excellent tools at their disposal, courtesy of the government: The Registered Retirement Savings Plan (RRSP) and the Tax-Free Savings Account (TFSA). Both accounts offer tax incentives when it comes to your retirement money and gives you the opportunity to grow your money long-term by investing in stocks, bonds, ETFs, and other assets.
US citizens have US tax consequences by contributing to TFSAs, investments in REITs, ETFs and mutual funds, so they should obtain tax advice before investing in those.
Contributions to TFSAs are from your after-tax funds as you do not get a tax deduction when you contribute. When you withdraw from your TFSA accounts, they are tax-free.
Contributions to RRSPs are from your before-tax funds as they are deducted from your income and no taxes are paid as a result. When you withdraw from your RRSP accounts, they are taxable as ordinary income.
TFSA Contribution Room
The annual TFSA contribution limit for the year 2023 is $6,500 and will be $7,000 for 2024. If you do not make use of the full contribution limit for any year, it is added to the following year and the contribution room grows. If you never contributed to a TFSA, then you would have $88,000 available for contribution in 2023 and $95,000 in 2024 provided you were 18 years or older and a resident of Canada since 2009 when the TFSA commenced. The amount of withdrawal that you make from your TFSA in the current year is added back to your contribution room in the following year.
TFSA Withdrawals
It is important to note that withdrawals from a TFSA account do not reduce the total amount of contributions you have already made for the year. Withdrawals, excluding qualifying transfers and specified distributions, made from your TFSA this year will only be added back to your TFSA contribution room at the beginning of the following year. Therefore, if not careful, there is chance of over contributing.
TFSA Over-Contribution
Contributions that are over your contribution room will be penalized with 1% tax each month, so make sure to keep track of your TFSA room and contributions to avoid this unfavorable penalty.
Over-contributions should be withdrawn immediately to minimize penalty.
RRSP Contribution Room
The annual RRSP contribution limit for the year is 18% of your earned income in the previous year, up to a maximum of $30,780 for 2023. If you do not make use of the full contribution limit for any year, it is added to the following year and the contribution room grows. Unlike the TFSA, any withdrawal that you make from your RRSP is not added back to your contribution room.
RRSP Contributions and Deductions
You can make RRSP contributions up to your accumulated contribution room. Contributions made from March 2, 2023 to February 29, 2024 must be claimed on your 2023 tax return. You can choose to deduct all, none or portion of the contributions in the current tax year and carry forward any unused portion to be deducted in a future tax year or years.
RRSP Withdrawals
RRSP withdrawals are taxable as ordinary income. Exceptions are when you withdraw from your RRSP under the Home Buyers’ Plan (HBP) or the Lifelong Learning Plan (LLP). If eligible, you can withdraw up to $35,000 under the HBP. You have start repaying 1/15th of the amount each year to your RRSP starting the 2nd following year by making an RRSP contribution and designating it as an HBP repayment. If you do not make a repayment you have to add the repayment shortfall to your income. If eligible, you can withdraw up to $10,000 per calendar year under the LLP, up to a maximum of $20,000 limit. Similar to the HBP, you have to make repayments. Amount of the LLP repayment required is 1/10th of the amount over 10 years.
RRSP Over-Contribution
The penalty for RRSP over-contributions is 1% per month for each month you are over the limit. CRA does allow a $2,000 grace amount for over-contributions. However, that amount is not tax deductible, but this $2,000 over RRSP deduction limit for the tax year is still tax sheltered.
The only way to remedy an RRSP contribution overpayment immediately is to withdraw the amount. That amount will be subject to taxation and taxes will be withheld. If you make the withdrawal of the over contribution in the same year or following year of contribution, or year in which you receive the assessment, you can claim a deduction to offset the RRSP withdrawal income. In such cases, you can also file Form T3012A so that the financial institution does not withhold taxes on the RRSP over-contribution withdrawal. The downside is that the form has to go through the CRA for approval and then the Financial Institution before the over-contribution can be withdrawn, which could take a long time.
To calculate and pay the RRSP over-contribution penalty, you have to file a T1-OVP return which is due 90 days after the calendar year end.
The above information is of a general nature only and should not be relied upon for specific situations. Call Marlies Y Hendricks, CPA at 416-766-3941 or submit email enquiry form below to set up a consultation.
