RRSPs, TFSAs and RRIFs explained

January 30, 2020

Registered Retirement Savings Plans (RRSPs) and Tax Fee Savings Accounts (TFSAs) are both tax sheltered ways to save and invest. RRSP accounts must wind up by the end of the calendar year in which you reach age 71, usually with a transfer to a Registered Retirement Income Fund (RRIF).

The difference between RRSPs and TFSAs lies in their tax treatment, but they are really mirror images of each other. With a TFSA you make the contribution in after-tax dollars. With the RRSP you get a tax break now and pay the tax later when it is withdrawn or converted to a RRIF.  

How RRSP’s work

When you make an RRSP contribution, you get a tax deduction which at the average rate is 42.5 cents per $1. At that rate putting $1,000 in your RRSP gives you a $425 tax deduction.  Your investments grow tax-free inside the RRSP, but you pay tax when money is withdrawn.

The withdrawal begins at the end of your age 71st year when RRSPs are converted to a RRIF. A RRIF is essentially an RRSP in reverse.  The rules require you to withdraw a certain amount each year based on a formula. More on RRIF’s below.

How much can you contribute to an RRSP?

The amount depends on your earned income for the previous year. For 2020, the contribution is limited to 18% of your 2019 earned income, to a maximum of $27,230 plus any carry-forward contribution room you may have.

As an example, if you do not have a company pension and earned $100,000 and have no carry forward room, you could contribute $18,000 in the 2020 tax year.

How TFSA’s work

The name confuses many Canadians because they think a TFSA is a savings account. But a TFSA can hold bonds, stocks and ETFs, as well as cash.

Tax Free Savings Accounts (TFSAs) were introduced in 2009 and as mentioned the difference between a TFSA and an RRSP is that a TFSA contribution is made with after tax money. The money also grows free of tax inside. Amounts withdrawn in any year can be added back, but only in the next calendar year.

Here’s an example: Suppose you had $100,000 in your TFSA on Jan. 1, 2019 and withdrew $10,000 on June 1, 2019. You could not put back the $10,000 until Jan. 1, 2020. In this case your contribution for 2020 would be: $10,000 plus the $6,000 annual contribution.

What is the 2020 contribution limit?

TFSA contribution limits rise in $500 increments based on inflation. The limit was last increased on Jan. 1, 2019 to $6,000, which is the 2020 limit.

Someone who has never contributed will have a cumulative contribution room of $69,500 in 2020.

RRSP vs TFSA

Which of these vehicles is better?  It depends on your age and life stage and investment goals. These should be discussed with your advisor.

How RRIFs work

Your RRSP is a savings plan, while a RRIF gives you income by cashing out your RRSP. It is the most popular and simple way Canadians turn their RRSPs into income streams. 

The minimum withdrawals  for RRIFs were relaxed in the 2015 federal budget. The changes recognized that Canadians are living longer and rates of return on investments are much lower than they were.  The changes reduced the required amount of withdrawals each year.

However, the basic rules stayed the same. When you convert the RRSP to a RRIF, you have several options:

  • You can take the money out of your RRSP as a lump sum;
  • You can keep the same investments and sell them bit by bit;
  • Or you can convert your RRSP into an annuity that pays a monthly amount for life.

Each has a tax liability. If you choose the second or third option, there are strict requirements about how much you have to take out of your RRIF each year.

What can you hold in a RRIF?

There are no restrictions on the type of investment you can hold in a RRIF. You can keep the RRSP holdings as is and sell the appropriate amounts. You can hold any combination of stocks, bonds, GICs, mutual funds or Exchange Traded Funds (ETFs).

But as interest rates fall, retirees are looking for ways to improve their income streams with RRIFs.

Harvest Portfolios, Managing Director, David Wysocki explored some of the options in a recent interview.  He noted that saving and investing strategies used to accumulate money during a working life are different from those used to manage your resources in retirement. Understanding the differences, and adapting your approach, is even more important in an era of very low interest rates, he said. 

For many investors the right mix involves a combination of fixed income investments and high quality, dividend paying stocks.

Stocks adds risk, but the alternative is the risk of not meeting your needs for cash flow, he said. As always, there is no one size that fits all and it is something to discuss with an advisor.

Read more about Harvest Portfolios Group here.

The views and/or opinions expressed in the article are of a general nature and are for informational purposes only. Article contents should not be considered as advice and/or a recommendation to purchase or sell the mentioned securities or used to engage in personal investment strategies. Investors should consult their investment advisor before making any investment decision. 

 

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