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What is an RRSP?

A Registered Retirement Savings Plan (RRSP) is an investment plan that is registered with the government to which you or your spouse contribute. RRSP contributions can be used to reduce your income tax.

How do you get an RRSP?

Set up your RRSP through a financial institution. There are many different vehicles for investing your RRSPs, including savings accounts, mutual funds, and term deposits. Your financial institution can help you pick the plan that is right for you.

How much can you save?

The government limits how much you can contribute to RRSP based on your income. Unused RRSP deductions can be carried forward for future use – your RRSP deduction limit is found on your Notice of Assessment. You can make RRSP contributions until December 31st of the year you turn 71 years of age, or until you convert your RRSP to a Registered Retirement Income Fund (RRIF), whichever comes first.

What are the advantages of an RRSP?

Tax benefits are the main motivation for contributing to an RRSP. By making the funds contributed to RRSP tax deductible, the government encourages Canadians to make their own provisions for their post-work lives. RRSP contributions provide a tax credit, which reduces your taxable income.

All profits made on investments within an RRSP account in the form of interest, dividends, or capital gains are tax sheltered; in other words, not immediately taxable to you as income. Funds in an RRSP are taxed at the time of withdrawal, unless they are going to be repaid as part of the First Time Home Buyer’s Plan or the Life Long Learning Plan. The benefit of this is that you are taxed during retirement when your income is, theoretically, lower.

What is a TFSA?

A Tax-Free Savings Account (TFSA) is a flexible investment account that can help you meet both your short- and long-term goals. Contributions are not tax deductible, but any earnings on the funds invested, whether its interest, dividends or capital gains, are tax-free, even if you withdraw them.

How do you set up a TFSA?

Set up your TFSA through a financial institution. There are many different investment vehicles for  TFSAs, including savings accounts, mutual funds, and term deposits.

How much can you save?

Each calendar year, you can contribute up to the TFSA dollar limit for the year, plus any unused TFSA contribution room from previous years. The current maximum annual contribution is $5500, making a total contribution limit of $52,000 as of January 2017. Note that if you go over the limit there is a penalty tax of 1% per month on the excess contribution.

Why should you get a TFSA?

The tax-free compound growth means that your money grows more quickly inside a TFSA than in a taxable account. In addition, funds can be moved in and out of a TFSA easily, and won’t affect your taxable income.

Let’s Compare: RRSP vs. TFSA

RRSP and TFSA are both great ways to help you save for the future. So how do you decide which one to use and when?

While it’s possible to withdraw from RRSPs, doing so is not unconditional. Withdrawals are taxable unless you are withdrawing for the purpose of buying a home (First Time Home Buyer’s Plan) or furthering your education (Life Long Learning Plan), in which case the funds must eventually be repaid. With TFSAs, you can withdraw the original funds plus earnings without paying tax.

That said, there is no immediate tax advantage for contributing to a TFSA. The advantages are only felt once significant growth has been made on the investments. In addition, the freedom to withdraw any time may make it tempting to use your TFSA as a regular savings account, which may interrupt financial growth.

It should also be noted that you can only contribute to your own TFSA, whereas RRSP offers a “spousal plan” in which you can contribute to your spouse’s RRSP, but claim the deductions on your own income: The higher-earning contributor then receives the short term benefit of the tax deduction for the contributions, and the lower-earning person claims the income during retirement, when they are in the lowest tax bracket.

For residents, consider contributing to your TFSA now and wait to make RRSP contributions when your income is higher post-residency. Alternatively, you can contribute to your RRSP during residency but defer the deduction until you are in a higher tax bracket. Keep in mind that Doctors of BC offers an RRSP matching program. The deadline for RRSP contributions for 2016 is March 1, 2017.

author: Melissa Nilan