What is an RRSP?
An RRSP (Registered Retirement Savings Plan) is an investment plan that is set up through a financial institution and registered with the government. One can invest in a variety of investments in their RRSPs including stocks, mutual funds, savings accounts, and term deposits.
When one makes a contribution into their RRSP, they are entitled to deduct this amount from their taxable income which could result in a tax refund. Any earnings from those investments are not taxed within the RRSP; however, withdrawals from the RRSP are taxable.
Ideally, one would contribute to their RRSP from their income during their working years when their income is high (and in a high tax bracket and thus maximize the tax deduction) and then withdraw the RRSPs during their retirement years when their income is low (and in a low tax bracket and minimize taxes paid on withdrawal).
Key Facts and Tips
- March 1, 2019 is the deadline for RRSP contributions for the 2018 tax return.
- The amount of RRSP contributions one can make (and deduct from income) is based on one’s prior year income. This deduction limit can be found on one’s tax Notice of Assessment.
- Since undeducted amounts are carried forward to future years, those who expect a higher income in the near future (e.g. post-residency) should wait until then to make a deduction.
- Avoid contributing in excess of one’s limit; contributions that exceed the limit by more than $2,000 are subjected to a penalty of 1% per month.
- Tax refund: The RRSP deduction can result in a tax refund; it is not a bad idea to use this refund for debt repayment or purchasing additional investments.
- Home Buyer’s Plan: First time home buyers can withdraw up to $25,000 tax-free (up to $50,000 per couple) from their RRSP provided the contributions were made at least 90 days before the withdrawal date. The amount needs to be repaid over 15 years.
- Doctors of BC RRSP Matching Program: Open to eligible practicing physicians.
- Income splitting: A high income spouse (at a high tax bracket) can deduct contributions made to their lower income spouse’s RRSP; the lower income spouse would be subjected to a lower tax rate upon withdrawal. Furthermore, RRSP withdrawals during retirement are eligible for spousal pension income splitting.
- Withdrawals are taxable: As such, RRSPs are NOT suitable for those who plan to make withdrawals on a regular basis before retirement. In retirement, those with significant amounts of other income could be at risk of OAS (Old Age Security) clawback.
What is a TFSA?
Like an RRSP, a TFSA (Tax Free Savings Account) is also an investment plan that is set up through a financial institution and registered with the government (TFSAs were introduced in 2009). Eligible investments mirror those for RRSPs including stocks, mutual funds, savings accounts, and term deposits.
Unlike an RRSP, one does not get a tax deduction for contributions made to a TFSA; however, investment earnings grow tax-free within the plan and all withdrawals are tax-free.
Key Facts and Tips
- The annual contribution limit is set by the government: $5,000 per year for 2009 – 2012, $5,500 per year for 2013 – 2014, $10,000 for 2015, $5,500 per year for 2016 – 2018, and $6,000 for 2019.
- The contribution limits are cumulative; unused amounts are carried forward to future years.
- One needs to keep proper records to ensure their limits are met at all times; excess contributions are subjected to a penalty of 1% per month. (One can also contact the Canada Revenue Agency (CRA) for their unused contribution limit.)
- TFSAs are NOT RECOMMENDED for US citizens since the TFSAs are still subjected to US tax.
- Tax-free withdrawals: Withdrawals are not taxed and one can withdraw funds as needed. Furthermore, withdrawals during retirement will not subject a taxpayer to OAS clawback.
- Contribution limit replenished with prior year withdrawals: Withdrawals are added back to the contribution limit in the following
- No income splitting: TFSAs cannot be used to split income from higher to lower income spouse.
- No tax deduction: Contributions are not deductible for tax.
Ultimately, while both RRSPs and TFSAs confer tax savings, their different attributes need to be considered for one’s prudent financial planning. Here are a couple of key recommendations:
- Since TFSA withdrawals are not taxable and the contribution limit is replenished in the following year, they are recommended for those who intend to withdraw from them before retirement.
- Since RRSPs result in a greater tax benefit for those in a high tax bracket, I recommend that residents contribute to TFSAs during residency and save the RRSP deductions for post-residency when their incomes are higher and they are eligible for the Doctors of BC RRSP Matching Program.
- An ideal time for making an RRSP contribution would be post-residency but prior to incorporation of the medical practice which would result in a larger tax reduction.
This article is courtesy of Richard Wong, CPA, CA of Baker Tilly WM LLP (formerly Wolrige Mahon LLP). Richard has extensive experience in providing accounting and tax services to physicians and other health professionals. For more information, Richard can be reached at firstname.lastname@example.org or at 604-691-6886.