Taxology - Episode 2: TFSA vs. RRSP, what’s the difference?

CC (Host): Savings and investments. You've probably heard your parents or family talk about them, and see ads on TV and YouTube from banks and other companies talking about retirement goals, and there's always that one friend who's got it all figured out, am I right? If you're practicing avoidance on this one, it's time to treat yourself to some financial self care so you can manifest your best financial future.

We're here to put you on the starting track. Welcome to Taxology, the new podcast from the Canada Revenue Agency where we talk about the super exciting world of taxes. I'm your host, CC, and on today's episode, we're going to talk about the Tax Free Savings Account, also known as the TFSA, and the Registered Retirement Savings Plan, also known as the RRSP.

Why do I always want to sing Aretha Franklin when I say that one? Sorry, now I know you're singing it too. Focus, CC, focus. Okay, so these are two very useful plans to help you save money throughout your life. We get a lot of questions about these, like what's the difference and why do I need to do this?

So let's dive in.

Joining us on the show today are two CRA employees, Sébastien and Nathan. Sébastien will explain both the TFSA and RRSP to us, their differences, and clear up some misconceptions you might have about them. And we'll talk to Nathan about common questions the CRA call centres get about TFSAs and RRSPs so we can save you a phone call.

So let's get started and introduce our first guest, Sébastien. Sébastien has worked in the TFSA program since its beginning in 2009. He has extensive knowledge of both plans and is here today to bestow that knowledge unto us. Welcome, and tell us a bit about yourself.

Sébastien: I started my career in CRA with the inception of TFSA.

TFSA was put in place in the budget 2009. From there, we started receiving correspondence from taxpayers in regards to some questions, rule, room statement, and many other questions. So we got caught up a bit by surprise because TFSA became popular and popular real quick. But it was an interesting time, and I was proud to be part of this program from the get go.

And now I've moved up to the headquarters department. Now, we oversee the rules and policies of the TFSA and follow the regulations.

CC: First and foremost, what is a Tax Free Savings Account?

Sébastien: It allows us to save as we go through our lifetime. You can withdraw money at any time without having to pay tax on the money withdrawn.

This includes money earned through growth from the account.

CC: Okay, so I can take it out at any time, like if I wanted to buy a house or if I had a spa day coming up?

Sébastien: Exactly, yes.

CC: How can I figure out what my contribution limit is to my TFSA?

Sébastien: So, to know what your contribution limit is, I would recommend that you visit My Account.

This is the fastest way to identify what your contribution room limit is at the beginning of the year. So right now we are in 2023. So if you wanted to know what your contribution limit is for 2023 as of January 1st, you would visit My Account and that information would be made available to you.

CC: Will my contribution limit change from year to year?

Sébastien: Depending on if any investments were made, if you had contributed prior to, your room starts to grow as when you turn 18 or become Canadian resident, so you have to be careful, not everybody has the same contribution room limit. So therefore, I would recommend to visit My Account to get the proper room limit for yourself.

CC: Oh my gosh, I don't have the same amount as my best friend?

Sébastien: It's it could be a possibility, yes.

CC: Okay, I should check. Can I have multiple TFSAs or can I only have one?

Sébastien: No, you can in fact have multiple TFSA with multiple financial institutions.

You just have to be careful because they all count towards your room limit. So therefore, you have to consider them as one in the end and verify your contribution room limit.

CC: So if I have like $20,000 to contribute, then it's not $20,000 per TFSA. It's $20,000 total.

Sébastien: Correct.

CC: Got it. How many TFSAs do you have?

Sébastien: I have one TFSA.

CC: Me too.

Sébastien: I'm lying. I have two.

CC: I have one that my dad helped me put together, but I didn't understand it until now, so thank you. What is a Registered Retirement Savings Plan?

Sébastien: So a Registered Retirement Savings Plan is a means for people to save for retirement. Unlike TFSA, it does have some tax implication and you can contribute as soon as you start working and earning income.

With the RRSP, you are deferring taxes. Your contributions are done pre-tax income, so contributions provide a deduction on your income tax return.

CC: So deferring means waiting until later?

Sébastien: Correct, yes. The deduction on your income tax return one of the great benefits of this is you can potentially claim a refund when doing your tax, all depending on the total contribution you have made.

That's a great advantage that the RRSP does have.

CC: Am I going to have a different limit for my RRSP and my TFSA?

Sébastien: Yes, because the RRSP is based on income.

CC: I see. So the more I make, the more I can contribute?

Sébastien: Correct.

CC: And the more I can set aside for my...

Sébastien: Your retirement.

CC: My island home.

Sébastien: The RRSP does have one great advantage to it as well is you're talking about your home when you are ready, you could use the funds that you put aside in your RRSP to make a purchase of your home via the Home Buyers’ Plan.

CC: Okay, what's that?

Sébastien: The Home Buyers’ Plan allows you to make a withdrawal from your RRSP, tax free, if you do make a purchase of a home. With the HBP rules, the Home Buyers’ Plan, sorry. You have 15 years to repay the amount that you have withdrawn. So it allows you to make a nice down payment for your first home and then take your time to repay it.

CC: Is 15 years a long time? I can't tell.

Sébastien: It's quite a long time, yes.

CC: Is it? Okay.

Sébastien: Oh yeah. It's plenty.

CC: Do a lot of people take advantage of the Home Buyers’ Plan?

Sébastien: Yes, there is quite a substantial amount of folks that do take advantage of the Home Buyers’ Plan.

CC: What's the difference between a TFSA and RRSP?

Sébastien: Okay, so I guess if we can go back on an RRSP versus a TFSA, there's some major difference, but there's some components to it that are very similar. We can start with similarities. So with a TFSA and an RRSP, you can hold many different investments, such as stocks, mutual funds, GIC, and those are all via your financial institution.

GIC, you can get a fixed interest. And those are both the most type of investment for which a Canadian can save up for different needs.

CC: Like if I wanted to buy a house or maybe save for my retirement?

Sébastien: Exactly. The RRSP is the way to go for that particular side of things. In regards to TFSA, some people use it for short term investments, which do have some benefits.

Let’s say you, something happens, you have to fix your car, you need money right away, so you can make a withdrawal tax free. That’s one big advantage versus the RRSPs. When we're thinking about RRSPs, it's, well, there is some particular rules that you have to be careful, but the big advantage with TFSA exactly is that you can make that withdrawal tax free.

You just have to be careful though, because once you make that withdrawal, you cannot technically add the funds back until the following year.

CC: I see. Okay. So I have to be really sure that I need that money that I'm taking out of the TFSA.

Sébastien: Correct. And also, when we're talking about investment funds, there's good components to it, such as any gains that you have made in your TFSA and that you withdraw will be added to your room. So, if you made a great investment, let's say you've invested in X stocks, you have a good feeling about some stocks and you buy, I don't know, a $5,000 worth and you do make a good return out of it and you decide to withdraw it to spoil yourself with that…

CC: Treat yourself.

Sébastien: Treat yourself with that great investment while that, let's say you made, I don't know, let's say $1,000 of interest, that interest gets added back to your room.

CC: Oh, okay.

Sébastien: It's an interesting component to it.

CC: Who can I talk to about TFSA advice?

Sébastien: So, I would recommend to talk to your financial advisor. All investment, of course, not everyone is in the same situation. It’s not a one size fits all. You have to identify your needs, what you're looking out of it. Again, it could be just a small GIC, which has a set fixed interest rate, or it could be again, like stocks that you want to invest and just to have to be careful because sometimes, when we want to, let's say, move funds around we have to be careful not to do that ourself. We always have to talk to our financial advisor to make sure that we are transferring funds in a way that will not cause any issues within the rules that are set in place. So, what I'm talking about is, we've often seen people go from one financial institution to another for, let's say, a better interest rate.

CC: Okay.

Sébastien: But to this, there's fees that are attached to it. You want to be careful.

CC: But what if one of the banks offers me a free iPad.

Sébastien: Yes, we've seen that in the past. And yes, they do offer. They try to entice more people. But you have to be careful when transferring, let's say, from bank A to a bank B.

You have to do it in the legal aspect of way. So, what I'm talking about is, there are forms usually that one F.I. will, one financial institution will have you complete to make it the proper way to transfer it. Do not transfer it yourself. We've seen that situation occur where people have transferred their funds from bank A to bank B to take advantage of some promotion that happened.

While when we do this type of, let's say, behavior, it will be considered as a new contribution.

CC: What happens if I over contribute to either my TFSA or my RRSPs? What happens? I mean, like, putting in more money into these accounts would be better in the long run, right?

Sébastien: No, because there are some tax implications to overcontributing to both your TFSA and RRSPs.

My recommendation is to withdraw that excess amount immediately and check with the CRA on what your options are.

CC: So what is the difference then between the First Home Savings Account and the Home Buyers’ Plan?

Sébastien: The First Home Savings Account combines features from the RRSP and TFSA. So it allows for a contribution to be deducted on your income tax return, just like an RRSP, but if the funds are withdrawn to purchase a qualifying home, the withdrawal will be tax free.

CC: So I can take the money out for, say, car repair, and it would be taxed, but then if I take it out to buy a house, it wouldn't be?

Sébastien: Correct.

CC: How much can I contribute towards the First Home Savings Account?

Sébastien: So you can contribute up to $8,000 per year. But we have to also to note that there is a lifetime limit, lifetime contribution limit of $40,000.

CC: And how long can I hold on to my FHSA?

Sébastien: So, the rules are that you can hold it for up to 15 years or until you turn 71.

CC: Oh, that's really specific.

Sébastien: Mm hmm.

CC: Why do we need another registered plan for housing when we already have the Home Buyers’ Plan?

Sébastien: So, like TFSA, the First Home Savings Account investment income isn't taxable and unlike the Home Buyers’ Plan, the participants don't need to pay back the amount and there is no withdrawal amount limit. I think the need for this one, I think it's a great investment plan for the younger generation as you don't need to have an RRSP first set up to make a withdrawal for the purchase of a home.

You can have that goal in mind right away. Somebody that just turned 18 can contribute $8,000 via the First Home Savings Account and withdraw it to make the purchase of a home. So, they are getting the tax deduction with that savings plan, but the great advantage is they do not have to repay it.

CC: If I've just turned 18, what is the first account that I should create? Should it be the First Home Savings Account? Should it be the RRSP? Should it be the TFSA? What should I do? What's the first thing I should do?

Sébastien: Again, I would say it's not one size fits all, all depending on the situation, the type of employment that you have.

If you have already a pension plan with your current employment, if the RRSPs is a great plan to contribute towards your later years once you decide to retire if you do not have a pension plan of your own, but again, I would speak with a financial advisor to see what best fits for your own situation.

CC: Do you have any other tips about any of these accounts?

Sébastien: Again, be careful. I would make sure to understand the rules before investing. You don't want to be caught up by some surprise. We've seen some Canadians make some mistakes in regard to TFSA by not knowing the full extent of the rules. Yes, it does look simply, but you have to always be careful and make sure that you do understand the rules regarding those type of investment to ensure that you meet the rules that are put in place.

If you're unsure or uncomfortable with our website, I would recommend calling our friends at GE. They're very helpful. They're very knowledgeable and they have the expertise to answer our questions.

CC: Our contact centre agents.

Sébastien: Our contact centre agents, yes.

CC: Awesome, thanks.

We're now joined by Nathan, who's worked at the CRA for over 20 years, and has spoken with thousands of taxpayers about a wide range of tax and benefit topics, including TFSAs and RRSPs. Nathan's also been around since the TFSA's birth, and will tell us about the most common questions he gets from Canadians about them.

Welcome back!

Nathan: Thanks for having me back in.

CC: So, we're talking today about TFSAs and RRSPs. What is the top question that we'd hear about these at the contact centres?

Nathan: Yeah, I think that taxpayers have a lot of questions about TFSAs, about RRSPs, about the new First Home Savings Account. The number one questions we get, unfortunately, at the contact centres deal with excess contributions.

CC: Hmm. Like if I've given too much?

Nathan: Right.

CC: Okay.

Nathan: So, because our agents don't offer financial advice, we don't get a lot of questions from folks who are looking to, to sort of maximize their saving situation. Unfortunately, we deal with situations a lot of the time where people have over contributed. I should say, we do answer a lot of other questions that are in happier situations.

So, folks call us looking for advice on how to complete the Schedule 7 of the tax return for their RRSP contributions and transfers. We do get a lot of questions for folks who are looking to confirm the amount of TFSA contribution room they have their RRSP deduction limit, but the number one topic is people who maybe have contributed too much.

And this can happen for a few different reasons. For TFSAs in particular, there has been a bit of a misunderstanding over the years about how the withdrawal rules work, right? So you can withdraw money from a TFSA with no tax consequence. And that’s one of the most significant differences between an RRSP and a TFSA.

So for an RRSP, the idea is that you are deferring taxation to a future year. So, you’re claiming a deduction when you’re contributing to the RRSP and then you’re going to be taxed on the money when you withdraw it. Usually, the idea is that you’re contributing when you’re earning higher income and withdrawing in retirement when your income will be lower. So that gives you an advantage.

For a TFSA, that’s not a factor. There is no deduction when you contribute and there's no immediate tax consequence when you withdraw. So with a TFSA, the idea is that this is a more flexible savings account. You can contribute and you can withdraw and you can do this whenever you want to during the year.

The problem is that there is an impact on the contribution room that you have available for your TFSA. If you withdraw money from a TFSA, you will get that contribution room back, but you don’t get it back until next year, right? So the rules have been built in a way that is meant to allow taxpayers to withdraw money and then to put it back in as they need, right?

You withdraw it when you need it, and then you're able to put it back later, but you don't get that room back right away. So, when taxpayers don't understand that that's how the rule works, sometimes they will withdraw money and then put it back too quickly and they haven't gotten their room back, and so they've accidentally over contributed.

CC: What's the difference between the TFSA and the RRSP and what can actually be invested into what? Like, what are the advantages and disadvantages? What should I even do?

Nathan: That's a simple question with a somewhat complicated answer. In a way, the TFSA and the RRSP and the First Home Savings Account are very similar.

What works best for you is, is a question that can be fairly complicated, right? And depends on, on what your savings goals are. So for the most part, and I didn't hear Sébastien's answer to this earlier, but I'm sure he explained some of this as well. For the most part, the principle behind the RRSP is that you're saving for retirement.

So the RRSP allows you to claim a tax deduction up front for the amount you've contributed, which will reduce your net income in the year. So you have a lower income, you're paying less for tax. Down the road when you withdraw money from the RRSP, you are taxed on that withdrawal. For most people, their income in retirement is lower than their income was while they were working, so they're paying less tax in retirement than they would be right now. That's sort of the idea.

The TFSA does not have a deduction or income inclusion rule built in. When it was announced, it was presented as a way to save money tax free and you can contribute and withdraw with no tax consequence.

Whether it's better for you to have an RRSP or a TFSA may depend on what your savings goals are and what your financial plan is. The First Home Savings Account actually sort of splits the difference between these two types of plans. So again, it allows you to hold similar types of investment properties in a plan where you're not paying tax on a yearly basis, right?

So you can grow your investment tax free for all three of these types of plans. The unique aspect of the First Home Savings Account is that you are able to deduct the contributions that you make to the plan, like an RRSP, but if you make a qualifying withdrawal to help purchase a home, you don't pay any tax on the withdrawal.

So the withdrawal doesn't get counted as income. If you qualify, and if you make a qualifying purchase of a new home, it can be like an RRSP when you contribute money, but like a TFSA when you withdraw, but that again will depend on what your financial plan is, right? Are you saving money to buy a home to take advantage of that rule?

CC: What are the top questions that we get at the call centres about these plans?

Nathan: Most of the questions that we receive are pretty straightforward. Although you can find your deduction limit, your contribution room in My Account, a lot of people still call us to check, right? Want to be sure that what they're, what they're looking at is correct, especially early in the year.

There is a special rule for RRSPs that allows you to make a contribution within the first 60 days of the year and claim that as a deduction on last year's tax return. So right before tax time, a lot of people do call us just to make sure how much room they've got available before they go to their financial institution and make that contribution.

So a lot of the questions we receive are very straightforward. For RRSPs, there can be some possibilities, right? Because of the tax consequence of contributing to an RRSP, claiming a deduction. The rules can be fairly complicated in some situations when you're moving money from one plan to another.

Especially if this is happening because of, say, a breakdown, a separation in a marriage or from one plan to another because someone has passed away. There are situations involving what we call transfers and a lot of people call us to ask questions about the transfer rules. For TFSAs, there isn't a similar issue with transfers.

It again is more folks calling to confirm their contribution room each year. But unfortunately, we also get a lot of questions for both of those about excess contributions, about people who've put in too much money.

CC: So what's so bad about putting too much money into these? Like, isn't it better to contribute more and set aside for my retirement?

Nathan: I would say it's certainly good to put in as much money as you can, as you're, as you are allowed to do. There are excess contribution taxes. So special taxes that will apply for both an RRSP and for a TFSA and for the new First Home Savings Account as well. There are excess contribution taxes that are calculated based on the amount of time that you have been in an over contribution scenario.

So you will have to calculate, month by month, a penalty for the amount that you've, that you've over contributed. The basic excess contribution tax, for instance, for an RRSP will be 1% of the value that you've over contributed calculated for each month. So, if you have an excess contribution for 12 months of the year, you'll be paying 1% of that total for each month.

So effectively 12% and it's, it's hard to earn an investment return that is, is going to be more than that rate. So generally you want to take this money out as soon as you can. So the processes for pulling these excess funds out of your RRSP or a TFSA, that generates a lot of phone calls for us. With an RRSP in particular, there are a few different options.

Right? You want to be able to deduct the amount that you're pulling out if you can, right? So that it's not being taxed as a taxable withdrawal. And I'll back up for a moment to say when you contribute too much to an RRSP you don't get to deduct that over contribution, right? So that is another reason that you don't want to do this.

Generally, you are deducting your contributions to an RRSP, but if you go over your deduction limit, you can't deduct that anymore. And if you don't withdraw that excess contribution properly, you will be taxed on the withdrawal. So this is part of the reason that we get a lot of phone calls about this in particular.

Right about what to do when someone is over contributed.

CC: This has been a lot of information. I think I understand it all. Can I take money out of my RRSP before I retire?

Nathan: Yes. You absolutely can. Most RRSPs allow for you to make a withdrawal essentially whenever you want to. There are some specialized scenarios where a plan might be what we call locked in, which would restrict your ability to make a withdrawal.

Often those involve funds that originally were held in a Registered Pension Plan. But yeah, there is nothing stopping you in most cases from withdrawing from an RRSP, even though it's intended to be savings. It's right in the name. It's intended to help you save for retirement. If you need the money now and you are willing to have this withdrawal treated as taxable income.

So, there will be tax to be paid on the withdrawal. You can make a withdrawal before you retire. There are two special situations where you might want to make a withdrawal from an RRSP prior to retirement that have been established as special procedures. So it is possible to make a withdrawal from an RRSP under the Home Buyers’ Plan.

This enables you basically to borrow money from your RRSP to put towards the purchase of a home. There are a set of rules around it. You have to be considered to be a first-time home buyer. But if you qualify, you can withdraw money from your RRSP under the Home Buyers’ Plan and then basically pay yourself back over time.

So over a period of up to 15 years, you are contributing back into your RRSP and designating that contribution as a repayment to your Home Buyers’ Plan. So you're borrowing the money from the RRSP yourself and then paying it back.

There's a similar program called the Lifelong Learning Plan that allows you to withdraw money for continuing education. So again, there are a set of rules around when you are able to do this to enable you to continue your education and then you repay the money to yourself, to your own RRSP over time afterwards.

CC: So it's like investing in yourself.

Nathan: It's like investing in yourself. I like that.

CC: That's awesome. But what happens if I still need help? Where can I get advice about this?

Nathan: There are a few resources that I would suggest checking out. The CRA website does have a lot of information on the rules for the TFSA, for the RRSP, for the new First Home Savings Account. So you can find some, some general guidance there.

I would always suggest registering for and using your CRA My Account because you will be able to find information about your specific RRSP or TFSA information there, even though it's not live you still do have to keep track during the year of how much you've contributed to your plans.

If you are a lower income, a modest income taxpayer at tax time, if you use the Community Volunteer Income Tax Program to help you prepare your return, you know, they can assist you with some straightforward situations for claiming your RRSP contributions, for deducting your RRSP contributions on your return. They won't be able to assist with the over contributions, but if you want to make sure you're on the right track and that you are reporting your RRSP contributions properly the first time around, they can help with that.

And if you have questions about some of the complex issues that can come about, if you have over contributed, unfortunately, yeah, you can give us a call for, for those situations as well.

CC: Any last tips about any of these plans?

Nathan: Any last tips? Yes. Before you contribute to any of these plans, I would say take a look at the advantages of the different types of plans to make sure you're making the right choice for yourself.

Once you have set up an RRSP or a TFSA or a First Home Savings Account, keep track of what you've done in that plan. So, try to keep your own record of what you've contributed and what you've withdrawn. There is going to be a year end statement for each of these, but you really want to make sure that you are on top of what you're doing so you don't end up accidentally having over contributed.

And you know what? I'll throw in one additional tip for the RRSP in particular. It is possible, if you are making regular contributions to an RRSP, and you are employed, to have your employer reduce the tax that's being withheld on your paycheck in a way that takes into account the deduction you'll be able to claim at year end for your RRSP contributions.

So there is a form that can be used to ask for a waiver from the CRA. To ask for the CRA to issue a, what we call a letter of authority to an employer to withhold less tax. So that is form T1213, Request for Reduction of Taxes at Source. I think that's the title if I remember correctly, but it's certainly the T1213 form.

If you're having regular contributions made to an RRSP, you can also just talk to your employer. And as long as they have a reasonable expectation that you're going to be able to claim this deduction. So they've seen, or they know what your deduction limit is, that you've got the room to make the deduction, they can go ahead and do this in some cases without a letter of authority. But you can, instead of waiting until tax time to get a nice big refund for all of the RRSP contributions that you made, you can just pay less tax during the year. Most people would rather have the money now than wait until tax time.

So, take a look into that. Talk to your employer if you're making regular RRSP contributions.

CC: Thanks so much for coming today, Nathan. Thanks for explaining this RRSP, TFSA, FHSA business, all of these acronyms. I think you've really helped to clear things up. Thank you.

Nathan: Thanks for having me. It's been a blast.

CC: And that's all we have for this episode of Taxology. We hope TFSAs and RRSPs don't scare you as much, and you can now make your plans so your future self thanks you down the line. A big thank you to our wonderful guests for joining us. If you'd like to learn more about anything discussed in today's episode, please visit Canada.ca/taxes or check us out on Facebook, Twitter, or Instagram @CanRevAgency. I'm your host, CC, and tune in for the next episode where we'll dive into the so called platform economy and how this might affect your taxes. Thanks for listening. Until next time, stay safe and do your taxes.