By: Massimo Satira
Posted on: June 26, 2016
Most of us remember opening our chequing and savings accounts and thinking “That’s it! Now I’m an adult.” But that was only the tip of the savings iceberg. Now that you’ve gotten yourself a steady income, it’s time to graduate from that starter savings account and start putting your money to work.
I personally have both an RRSP and TFSA and, to me, they’re simply enhanced savings accounts. I’m going to walk you through exactly how these accounts can help you save more (hopefully that’s what you want to do) and by the end of this article you should at least be able to tell your friends what these acronyms stand for.
The one thing RRSPs or Registered Retirement Savings Plans are known for is their juicy tax returns. This is because RRSPs are tax-deferred. That means the government gives you the tax back now but expects you to pay it when you withdraw the money.
Let’s say you made $45,000 last year and deposited $2,000 (after tax) into an RRSP. In the government’s eyes, you should’ve only been taxed on $43,000 of your income ($45,000-$2,000) and will give you back that taxed money in your refund. This means the more you contribute, the bigger bonus you can get at the end of the year (and more to spend on that Schwinn bike you’ve had your eye on.)
The only downside is the money you deposit is earmarked for retirement. If you withdraw it before you retire, you’ll pay pretty hefty penalties. And, if you deposit more than your maximum contribution room (18% of your income every year), you’ll also get penalized.
However, there are two ways to get your money out:
- If you’re buying your first house (Home Buyers’ Plan), you can withdraw up to $25,000
- If you’re going back to school (Lifelong Learning Plan), you can withdraw $10,000 a year, up to a maximum of $20,000
There are specific rules around each of these programs (you’ll eventually need to pay this money back), but essentially they let you access to your money without penalty.
The TFSA or Tax-Free Savings Account is the mirror image of an RRSP. You won’t get any tax money back on what you deposit, but the government allows you to make withdrawals tax-free. And, as an added bonus, you can withdraw the money whenever you need it.
TFSAs also have a maximum contribution room. If you were 18 when the TFSA began in 2009, and you have yet to open one, you have a whopping $46,500 available. If you weren’t 18, then your contribution room starts on your 18th birthday. The yearly contribution room has changed often, right now it grows by $5,500 a year. That means every year, you can deposit another $5,500. Just like an RRSP, if you go over your contribution room they penalize you. Also, when you withdraw funds, you don’t automatically get that amount back in contribution room. You have to wait until the next year for it to renew.
For example, say I’m Drake and I maxed out my TFSA at $46,500 with my Views money. I take out $5000 to buy a Yeezy Season 3 Jacket, so my account balance is $41,500. I can’t re-deposit that $5,000 until 2017. In 2017, the government will also give me another $5,500 in room PLUS I’ll have the $5,000 that my withdrawal created. Since, I’m Drake and I’m a boss, I put in another $10,500 on January 1 without penalty.
So what type of account is right for you?
Everyone’s situation is different, and while I’m no financial advisor, there are some general guidelines I follow.
- Your income. You’ll get a hell of a lot more money back if you’re in a higher tax bracket when you contribute to your RRSP. The savings really start to add up once you start making $90,000. If you’re like me and fall short of that amount, a TFSA is generally the better choice. Save your RRSP contribution room for when you’re making more and can take advantage of higher tax returns.
- Psychological aspect. The fact you can’t touch your RRSP unless you’re buying a house or going back to school is a great savings motivator. A lot of my friends use this tactic and are saving a $25,000 down payment for a house in their RRSP. If you need this psychological push to save then open an RRSP and start putting money away for that starter home.
At the end of the day as long as you’re putting away money you’re on the right path. So open an account and start saving what you can. Good luck and if you have any questions, leave them in the comments section below and I’ll do my best to answer them.