Canto 8

RRSPs versus TFSAs

So let's assume that you've decided to start saving for a long-term objective, such as retirement. As a Canadian, you can choose between two main tax-sheltered types of accounts. The Registered Retirement Savings Plan (RRSP) lets people subtract the money they put in from the income they report on their tax forms, but then they have to pay tax on the money when they take it out. The Tax-Free Savings Account (TFSA) doesn't let people subtract the contribution from their income on their tax forms in that year, but they don't have to pay tax on the money when they take it out. (By the way, for US readers, the RRSP is something like the IRA in the US, and the TFSA is something like the Roth IRA. I'm not going to talk about those here - you should find another article about them.)

How are they similar?

The RRSP has been around since 1957 and the TFSA has only been around since 2009, but there are lots of things about them that are similar:

• You can generally establish accounts for either in most of the same places. You can set them up at a bank, a brokerage, an on-line broker, and a bunch of other kinds of places.
• You can generally keep the same kinds of things in them: stocks, bonds, mutual funds, ETFs. You can probably even hold pork bellies in your RRSP or TFSA if you want to.
• With either of them, you can choose how much hand-holding you get from the place where you set up your account. For example, most of the accounts you set up at a bank are structured so that the bank has a duty to advise you on what investments you should make, based on your risk tolerance and the amount of time until you will need the money. At the other end of the scale, you can set up a "self-directed" account at an on-line broker, and they will pretty much leave you alone to make your own choices.
• With both of them, you don't have to report the earnings of the account when those earnings are just staying in the account and not being given to you. They act differently when you start taking money out.

How are they different?

From a tax standpoint, RRSPs and TFSAs are kind of inverses of each other, but there are also other differences:

• When you put your money into your RRSP account, you are allowed to subtract the amount you put in (as long as you didn't exceed your limit for the year) from the income you report on your tax form. In fact, if you put it in before then end of February, you can subtract the amount from the previous year's income. Then you'll get a tax refund just a couple of months later. When you put your money into your TFSA, you don't subtract it from your income on your tax form.
• When you take the money out, you have to pay tax on your RRSP withdrawal as though it is new income in that year. When you take money out of the TFSA, you don't have to report it as income or pay tax on it.
• One implication of that is that the income that happens in an RRSP during the years when it was just growing does get taxed as you remove it. The income that happens in the TFSA during its years of growth never actually gets taxed.
• The other implication is that the RRSP kind of lets you move the year when income seems to occur, from the viewpoint of Canada Revenue. Basically you are canceling some income in the current year and having it pop into existence in a much later year. You would do that if you think your current income is likely higher than it will be when you need the money. If you think you make less money now than you likely will when you need the money, you should not use an RRSP. A TFSA is a much better plan for that situation.
• A lot of institutions are marketing TFSA accounts that are basically just savings accounts or GICs. (Not sure why, but RRSPs like that are not pushed to the same extent.) That would mean you'd be saving for a long-term objective using only the "cash" category of investments. Go back to Canto 2 to find out why that's dumb. Also, you're going to all the trouble of setting up this fancy type of account in order to get a tax break on a minuscule amount of income. If you're not going to hold income or equity types of investments in your TFSA, don't even bother.
• They have different contribution limits. In 2014, you can put up to 18% of your previous year's income up to a maximum of $24,270 into an RRSP. You have to adjust this if your employer provides a pension for you. You can put up to $5,500 in a TFSA. In both cases, unused contribution limits from previous years accumulate.
• You can't put any new money into an RRSP after you are 71. You have to roll it over into a Registered Retirement Income Fund, after which it is mandatory to start taking the money out. You don't have to stop funding a TFSA after 71, or take money out of it if you don't want to.
• There are only two reasons you can take money out of an RRSP before retirement, without paying penalties: buying a house, or pursuing a higher education. Then there are strict requirements for paying the money back in. The TFSA is much more flexible about allowing withdrawals.

What if you have to file taxes to the US?

My kids are dual citizens, so once they get beyond a certain income threshold, they're going to have to file to the US. The RRSP is recognized as a retirement tax shelter by the IRS, and although you still have to report it in a couple of ways, it's not all that onerous.

The TFSA requires the same level of reporting as we've been doing for the Registered Education Savings Plan (RESP):

• We report the income on our 1040 form,
• We report it as a foreign account on the Foreign Bank Account Reporting (FBAR) form,
• We have to make up our own 3520A form even though the IRS seems to expect our bank to do that for us,
• We have to fill out the 3520 based on the 3520A we made up, and
• We have to report the mutual funds held in the account in an 8621.

We're filling out all these forms for accounts on which we have never owed any tax to the US, but if we don't fill them out (or if we screw them up) we can be subjected to fines. It's truly ridiculous. So if you have to file to the US, think twice before setting up a TFSA. If you're not comfortable around tax forms, you're going to need lots of help.

So which should you choose?

If you make less than about $43,000 per year at the moment, you probably don't want to start an RRSP. Chances are you'll be making more money in the year when you want to use the money, so you'll pay more tax altogether. If you're making less than that, you should probably choose a TFSA. (If you have to file taxes to the IRS, get some help to figure out what it's going to mean in terms of filing requirements.)

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