Saving for retirement appears to be a simple concept: set aside a small amount of money each month, and it will eventually grow into a sizable nest egg. However, as you begin to do some research, head-scratching acronyms like RRSP, RRIF, TFSA and messages about tax implications begin to appear, and suddenly setting money aside can become quite confusing.
The good news is that if you are looking to decode and understand the benefits of an RRSP, RRIF and a TFSA then you’ve come to the right place.
We’ve compiled some very useful information into three sections (RRSP, RRIF and TFSA) to give you a well-rounded education on the main retirement tools in Canada.
Let’s get started…
What is an RRSP?
RRSP, which stands for Registered Retirement Savings Plan is probably the most commonly heard acronym of the three and that might be because it is the oldest. It was introduced way back in 1957 to provide tax-assisted retirement savings for Canadians.
The idea then, as it is today, was to encourage Canadians to save for retirement while also offering tax advantages.
How Does an RRSP work?
- Contributing to an RRSP on a regular basis puts you on the path to wealth creation. Your money will grow over time thanks to the power of compounding interest if you set up weekly or monthly automatic contributions. Begin early and contribute as much as you can given your total household budget.
- Of course one of the reasons you hear about RRSPs this time of year in particular, is because of the tax deduction. The tax deduction is a wonderful thing, but you must also consider your own situation.
- How much you are allowed to contribute to an RRSP every year is based on your income. The limit for 2023 is equal to 18 percent of your 2022 earned income, or $30,780 (whichever is lower) in addition to any unused contribution from previous years.
- You can check your most recent notice of assessment from CRA to find your available RRSP contribution room.
- Funds that are contributed to your RRSP can be invested in a number of ways including stocks, bonds, mutual funds and guaranteed investment funds (which my regular readers will recognize). As your RRSP grows, you are building a nest-egg for retirement, and depending on the investment, you will be earning more than if it was sitting in a savings account.
- You can withdraw funds from your RRSP at any time, but you will pay tax on the withdrawal at your marginal tax rate.
- Contributing to an RRSP will help reduce your annual taxable income during peak earning years. The idea is of course that when the time comes for you to be making withdrawals later in life, you will be taxed at a lower rate because you will no longer be working.
- Nobody likes to think about dying, but estate planning is important. IF you were to pass away, the balance of your RRSP would be transferred to your designated beneficiary.
As you all already know, It is very important to keep your estate plan up to date.
What is a RRIF?
A RRIF is a Registered Retirement Income Fund and they were established in 1978. When you are ready to begin withdrawing retirement income from your RRSP account, you open an RRIF account. So, if an RRSP is for saving and RRIF is for withdrawing.
How does a RRIF Work?
- A RRIF is established when you want to start drawing an income from your RRSP investment.
- There is an age limit for contributing to an RRSP, and when you reach that age (71) you must convert your savings plan (RRSP) into an income plan (RRIF). A RRIF is simply the evolution of an RRSP, and the next step in the retirement investment process.
- You set up your RRIF to pay yourself a regular income while your money keeps growing without tax while it is in the RRIF.
- As mentioned above, RRSP funds must be converted into a RRIF by the time you turn 71. You have until December 31st of that year to do so. You can set up a RRIF at any age, but age 71 is the latest age to do so.
- Unlike an RRSP, you cannot contribute to a RRIF, only withdrawals.
- Once your RRIF is set-up, there is a minimum withdrawal limit, which is based on your age. For example, at age 65 the minimum withdrawal is 4 per cent of the amount in your RRIF account, whereas someone in their 90s must withdraw over 20 per cent or the amount.
- There is no withdrawal maximum, so you can take out as much as you like each year, however it is considered income so you will be taxed on those withdrawals. The withdrawals are taxed at your marginal tax rate.
- Similar to your RRSP, if you were to pass away before you’ve withdrawn all the money from your RRIF, the balance would be transferred to your designated beneficiary.
What is a TFSA?
TFSA stands for Tax-Free Savings Account, and they were introduced in 2009. A TFSA is designed to be a flexible way for Canadians to grow their money in a tax-free environment. It is a really useful way to build savings that don’t have to be for retirement.
How does a TFSA work?
- The most significant benefit of contributing to a TFSA is that contributions grow tax-free, hence the name.
- You can own the same investments in a TFSA as you can in a RRSP or RRIF so stocks, bonds, mututal funds, guaranteed investment funds and the earnings from interest.
- A TFSA can be a very useful account if you’re saving up for a big trip, a new car, new furniture, or home renovations (you get the idea). When you want to withdraw your money, it is simple to do so.
- There is a limit to how much you can contribute. For the year 2023 you can add $6,500 into your TFSA. If you have never contributed to your TFSA before and were at least 18 years old when the program began in 2009, you will have a $88,000 cumulative limit in 2023.
- Be wary of over-contributions, which are subject to CRA penalties. The penalty is 1% of the highest amount per month that exceeds your contribution limit. To avoid the penalty, you can withdraw that amount.
- If you choose to fund your retirement income with a TFSA, withdrawals do not count as income and will not affect income-tested benefits such as Old Age Security payments.
- You will want to name a beneficiary for your TFSA as part of your estate planning.
Developing a basic understanding of the retirement tools available to you in Canada will help you move toward retirement a little faster. With a little working knowledge of an RRSP, RRIF and a TFSA, hopefully we can all look forward to happy retirements.
As always, I look forward to your feedback.
THIS ARTICLE IS PROVIDED AS A GENERAL SOURCE OF INFORMATION ONLY AND SHOULD NOT BE CONSIDERED TO BE PERSONAL INVESTMENT OR LEGAL ADVICE. READERS SHOULD CONSULT WITH THEIR FINANCIAL OR LEGAL ADVISOR TO ENSURE IT IS SUITABLE FOR THEIR CIRCUMSTANCES.