At 18 years old, my mom told me that I should open up a TFSA account. My response was, “What’s that? What should I do with it?” She said that the money in the account is tax free but didn’t go into depth about how I should be using it. This fuelled me to research and ask my friends and family about what a TFSA account is.
Similarly, on a recent Facetime call with my friends, we talked about what RRSP accounts are. We were saying how these types of accounts are things that we should learn in school. But, we were never taught and were really intimidated by it.
That’s why I’m here today to help you break it down. I want to give you the basics of what these accounts are and how you should use them!
*Disclaimer: I am not a finance professional and you should take my advice with a grain of salt. This is what works for me and always do you own research and consult a professional when managing your finances.
Tax-Free Savings Account (TFSA)
What is it?
Put simply, a TFSA account is an account that you don’t need to pay tax on. A more full definition from the CRA is:
The TFSA program began in 2009. It is a way for individuals who are 18 years of age or older and who have a valid social insurance number (SIN) to set money aside tax-free throughout their lifetime.
Contributions to a TFSA are not deductible for income tax purposes. Any amount contributed as well as any income earned in the account (for example, investment income and capital gains) is generally tax-free, even when it is withdrawn.
Administrative or other fees in relation to a TFSA and any interest on money borrowed to contribute to a TFSA are not tax-deductible.
– Canada Revenue Agency
Normally, the interest you earn in a savings or chequing account is taxed when you file your taxes. A TFSA account gives you an advantage by not needing to pay taxes on the money in this account. Essentially, moving your money into this account saves you money, for free!
What is my contribution limit?
Now of course, the TFSA account has certain restrictions to it. You are allowed a certain contribution limit for your TFSA each year. This amount also accumulates. If you didn’t use up your contribution in previous years, you will be able to contribute the total unused amount this year.
For 2021, the contribution limit is $6,000. You can view your specific contribution limit when you login to your CRA account. Scroll down to the section titled, RRSP and TFSA. This will show you your limit for 2021 (it will be greater than $6,000 if you didn’t use it previously). Note that depending on when you check this, it may not have calculated your 2020 contributions, so double check this amount against your personal records.
On that note, record your TFSA contributions on your own and don’t strictly rely on the information on your CRA account, since it doesn’t update throughout the year. If you contribute more than your contribution limit, you will be FINED by the CRA. So it’s really important to record your contributions!
Also, when you withdraw from your TFSA account, that amount is not re-added back into your TFSA contribution limit until the following calendar year. Be mindful of how much you’re withdrawing and make sure you don’t end up overcontributing!
How should I use it?
First, decide what your goal of opening a TFSA account is. You can either use it to invest, or save. Most financial institutions will offer different types of TFSAs. You can also have multiple TFSA accounts, but remember that your contribution room is for all of your TFSA accounts. For example, if I have a TFSA with RBC and one with TD, I can only contribute $6,000 this year amongst both accounts. I can contribute $4,000 to RBC and $2,000 to TD, but not $6,000 to both.
Investing
If your goal is to invest, you also want to consider how involved you want to be in your investments. There are many options available but the general ones are:
- Having someone manage your funds for you
- A robo-investor
- You managing your funds yourself
To get someone to manage your money, you want to look for a financial or investment advisor. They will discuss with you your goals and build a plan to invest to help you reach these goals. If you don’t want to speak with someone directly, you can explore the world of robo-investors, such as WealthSimple, where you can input your risk tolerance and preferences. Their system will then invest your funds for you to meet your preferences. Lastly, if you want complete control over your funds and manage your investments yourself, you can open a direct investing account, where you will place your trades yourself.
When investing with your TFSA, the benefit is that the returns you receive (if you make money by investing) will not be taxed. Normally, they would be taxed as capital gains, but not with the TFSA.
Saving
If you’re looking for more of a safer route with your TFSA account, you can open a TFSA Savings account. These typically allow you to earn interest without having to pay tax on that interest, as you normally would with a regular savings account. To make the most of it, look for a high interest TFSA Savings account!
How to get started?
Once you’ve decided how you’re going to use your TFSA, you’ll need to decide where you want to open your TFSA. Research different financial institutions and see what types of accounts they offer and what fees or conditions they may have. Once you open your account, you’ll be able to start contributing. Record every contribution you make and then begin investing or saving!
Registered Retirement Savings Plan (RRSP)
What is it?
A RRSP is a retirement savings plan that you can contribute to. It provides a tax advantage by reducing your yearly income, leaving you in a lower tier tax bracket. In other words, you can claim your RRSP contributions as a deduction on your tax returns.
When you withdraw money from your RRSP account, you will be taxed on that amount as income.
For a more formal definition from the CRA:
An RRSP is a retirement savings plan that you establish, that we register, and to which you or your spouse or common-law partner contribute. Deductible RRSP contributions can be used to reduce your tax.
Any income you earn in the RRSP is usually exempt from tax as long as the funds remain in the plan; you generally have to pay tax when you receive payments from the plan.
– Canada Revenue Agency
What is my contribution limit?
Your contribution limit will be different for everyone, as it’s 18% of your income. You can find your specific contribution limit when you login to your CRA account, under the RRSP and TFSA section.
With the RRSP, your contribution timeline is a bit different from TFSA. You’re allowed to contribute to your RRSP and claim a deduction on your 2020 tax return from March 3, 2020 to March 1, 2021.
How should I use it?
The purpose of a RRSP is to have money saved for your retirement. The benefit of putting away money into your RRSP is to pay less on taxes now (by reducing your annual income, bringing you to a lower tax bracket). When you withdraw the money for retirement, you will only be receiving income from any pensions you have (ex. Canadian Pension Plan). Thus, when you pay income tax on the amount that you withdraw from the account, you will (ideally) still be in a lower tax bracket than you are at now (if you didn’t contribute to your RRSP).
Similarly to your TFSA account, you can use the funds in your RRSP account to simply save or invest.
On the other hand, your RRSP also can give you benefits when you’re purchasing your first home, with the Home Buyers’ Plan. This plan allows you to withdraw funds ($35,000 or less) from your RRSP tax-free. You will need to pay back the withdrawn funds within a 15-year period. This is a great way to save for a house with a RRSP if that’s your goal! You’ll be able to invest or receive high interest when saving (without being taxed) and then withdraw those funds for the Home Buyers’ Plan tax-free.
In Conclusion
Ultimately, this blog post was a very basic and beginner’s guide to TFSA and RRSP accounts. There are definitely a lot more details that I wasn’t able to include! For more resources and information on these types of accounts, please visit the CRA website. I hope you found this helpful and a good start to managing your finances! Let me know if you have any questions by leaving a comment below, emailing me or sliding into my Instagram DMs.
