RRSPs and TFSAs – Canadians are still confused
We all know that saving for the future is a good thing. The message is, put a little money away every time you get paid. As simple as it may seem, many of us struggle to save or find better ways to do it.
Savings rates in Canada have dropped dramatically in the last 40 years, raising concerns that we are not saving enough to have the future we dream about.
For example, in the 1980s, our average savings rate was above 20 per cent. Back then, we saved 20 cents on every dollar we made. Fast forward to today, our savings rate has plummeted to less than five per cent, on average. New data from Statistics Canada reveals, in 2018, Canadian households had an average net savings of $852.
Add this to a host of new ways to save and invest, and many Canadians are confused about what is the best investment path for them.
A new survey from TD confirms that many (27 per cent) of Canadians still don’t know the difference between the Tax Free Savings Account (TFSA) and the Registered Retirement Savings Plan (RRSP). The survey reveals that most know that these tax efficient registered accounts are a crucial part of their savings strategy, but they don’t know how to use them.
“Regardless of whether you’re planning for long-term retirement or for a shorter-term goal, RRSPs and TFSAs are two popular and important options to help grow your savings,” says Jenny Diplock, associate vice president, personal savings and investing at TD.
“Many Canadians have both short- and long-term goals, so a mix of both TFSAs and RRSPs is often a good solution,” Diplock adds. “However, it’s important to understand the key differences between the two so you can feel confident about having the right plan in place to help meet your financial needs and goals.”
Thirty-five per cent of survey respondents say they don’t understand the tax implications of a TFSA, and another 30 per cent say the same when it comes to an RRSP.
Here’s how the two plans work
Contributions into your RRSP are not subjected to income tax, in the year they are made. If you have already paid, you are refunded the income tax you remitted on your top income, and the money you invest grows in the account tax-free. When you decide to withdraw the money in retirement, that money is then subject to income tax. The thinking is the refund you get on money earned while working will be more than what you pay in retirement, since retirement income is often less than working income.
The TFSA is different. Currently, you can contribute up to $6,000 a year. The money contributed is after-tax income. That money grows tax-free and when you withdraw it is not subject to income tax. This can be a bonus in retirement for those trying to maximize their income-tested government benefits.
Generally, the RRSP is great for earners in the highest marginal tax bracket, who pay the most income tax. And the TFSA is a good option for lower earners, who expect their income to remain low throughout their career.
“The survey data shows that many Canadians do not fully understand key characteristics of a TFSA and an RRSP, such as the tax benefits and withdrawal considerations,” says Diplock, suggesting people work with financial advisors to get more specific guidance.
Both the TFSA and the RRSP are powerful tax-efficient savings vehicles, and the best way to understand them is to start using them. By making contributions and investing money, you will see how your personal finances are affected, and can make decisions based on your learned experience of both.
RUBINA AHMED-HAQ is a journalist and personal finance expert. She is HPG’s Finance Editor. She regularly appears on CBC Radio and TV. She is a contributor on CTV Your Morning and Global Toronto. She has a BA from York University, received her post graduate journalism diploma from Humber College and has completed the CSC. Follow her on Twitter @alwayssavemoney.