Everything you need to know about RRSPs, TFSAs and RESPs

With the March 1 RRSP deadline just a few weeks away, many savers are no doubt asking themselves whether they should be putting money into this stalwart retirement account or if they should be investing in the decade-old tax-free savings account, or their Registered Education Savings Plan (RESP), instead. While it’s good to save in any of these vehicles, which one to use first will depend on how much you have to save and what you want to do with your dollars. With the RRSP deadline approaching, we thought we’d take another look at these three accounts.

RRSP: Still a solid retirement savings account

The Registered Retirement Savings Plan was created by the Federal government 62 years ago to help Canadians to save more for their golden years. At the time, people could only put away 10% of their income up to a maximum of $2,500. While a lot has changed since then, the RRSP has stayed mostly the same. Canadians can still contribute a percentage of their earnings, though it’s now 18% of people’s income up to a maximum of $26,500 for the 2019 year (this year’s deadline is in 2020). Any unused contribution room carries forward year after year. There are two big benefits to the RRSP. The first is that any money invested in the account can grow tax-free free until it’s withdrawn. So, if you invest in shares that climb by 20% and then decide to sell to buy something else, you won’t have to pay any tax on those capital gains like you would if you held it in a non-registered account.

RELATED: What’s my RRSP contribution limit?

The other advantage is that RRSP contributions reduce your taxable income. If you’re in a high tax bracket, investing an in RRSP could help push you into a lower one. You’ll also receive a tax receipt based on the amount of money you contribute, which you should put right back into the account. According to Ernst & Young’s 2018 RRSP savings calculator, if you live in Ontario and make $150,000 and put $20,000 in the account, you’ll save $8,847 in tax. But while money can grow tax-free, once you remove funds, likely in retirement, the Canada Revenue Agency will come for its share. That’s why RRSPs work best for people who save when they’re in a high tax bracket and then pull money out when they’re in a lower one. In fact, that’s the entire point of the RRSP—to save more money on tax in your working years and then pay less tax when you have to withdraw in retirement. The RRSP has some other uses, too, like the Home Buyers’ Plan, which allows people to remove $25,000 from their account to pay for a first home without having to pay a penalty, as long as the borrowed funds are re-invested within 15 years.

TFSA: Good for almost anything

The TFSA is the baby of Canadian savings account, having only been created a decade ago by Stephen Harper’s Conservative government. Over the last 10 years, though, it’s become the go-to investment account for many Canadians. Like the RRSP, money inside of a TSFA can grow tax-free. The big difference is that any deposits are done with after-tax dollars. So, while you don’t get a tax receipt, you also don’t get taxed on any money when you withdraw. Many people like this account because the math is easy: If you put $5,000 into the account and it grows to $50,000, the entire amount is yours. The TFSA is ideal for people in lower tax brackets who will end up in the same income bracket in retirement as they’re in now. It’s also good for those who can’t max out their RRSPs. On January 1, Canadians were given an extra $500 in TFSA contribution room, pushing the annual contribution limit to $6,000. If you haven’t put anything in your TFSA since 2009, you’ll now have $63,500 of room to use. That’s a decent chunk of change, but if you’ll still save more if you’re able to max out your RRSP. The other big difference between the TFSA and RRSP is that because money inside of a TFSA can be withdrawn tax-free, many people use it for short-term savings. It’s a good place to grow a downpayment for a house or to sock away some money for a few years. However, now that total contribution room has expanded to more than $60,000, it’s also a decent place for your retirement savings too. If you do want to invest in a TFSA for retirement, you will need to resist the urge to use those funds. People tend to avoid removing money from an RRSP early because of the tax hit.

RESP: Earmark money for education

The RESP is specifically for education savings. The main benefit of using one is that the government chips in 20% of what you invest—they call it a Canadian Education Savings Grant (CESG)—up to a max of $2,500 per year. That’s $500 in free money. There are a couple things to keep in mind: You can only contribute $50,000 total to an RESP, though investment gains can exceed that, and the CESG tops out at $7200. Most experts suggest investing $2,500 a year and no more since you mostly just want to get that grant. (If you miss a year, you can contribute $5,000 and get a grant for two years, but you can’t put in, say, $10,000 and get a grant for four missed years.) If you do want to invest more than $2,500 a year for education, consider putting additional funds in a TFSA. Why? Because while the money inside of an RESP also grows tax-free, you will have to pay the CRA on the CESG and on any investment gains when you withdraw. (The actual contributions are made after-tax, so you don’t get dinged on that $2,500 deposit.) Fortunately, those funds get taxed in the student’s hands, and most 18-year-olds pay little or no tax. There are some other RESP-related issues that people should be aware of too, like the rules around rolling over unused funds into a RRSP and how family RESPs work, but if you want to save money for university, then make use of this account. There’s no right answer way to save, though taking care of your retirement first, though an RRSP or a TFSA may be a good way to go. March 1 may be the RRSP deadline, but consider using that date as motivation to put money away in whatever account you like most.

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James Riva says:

December 10, 2020 at 1:05 pm

Hello. I believe RRSPs become LIFs at age 70 or 71? Can one continue to contribute to LIFs to improve annual release of funds or are the fixed and cannot be grown.

I look forward to your response(s)

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1. MoneySense Editors says:
  
  December 15, 2020 at 7:22 am
  
  Due to the large volume of comments we receive, we regret that we are unable to respond directly to each one. We invite you to email your question to [email protected], where it will be considered for a future response by one of our expert columnists. For personal advice, we suggest consulting with your financial institution or a qualified advisor.
  
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