Knowing the difference between RRSPs and TFSAs and why they're important for your retirement
About a quarter of Canadians don’t understand the difference between a tax-free savings account (TFSA) and a registered retirement savings plan (RRSP), despite most agreeing both are crucial to their savings strategy, a new survey reveals.
The TD Bank survey published Monday shows 27 per cent of Canadians do not understand what distinguishes a TFSA, a savings account that allows Canadians to earn tax-free investment income, from an RRSP, a tax-deferred retirement savings vehicle in which contributions are tax deductible.
The prevalence of that knowledge gap exists despite the majority of Canadians agreeing that TFSAs (59 per cent) and RRSPs (57 per cent) are important savings vehicles.
“Many Canadians have both short- and long-term goals, so a mix of both TFSAs and RRSPs is often a good solution,” Jenny Diplock, associate vice president of Personal Savings and Investing at TD Bank, said in a release.
“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.”
Just over one-in-five respondents said they would choose a TFSA to help reduce their taxable income for the following year — even though TFSAs do not work that way.
“The belief that having a TFSA investment reduces your taxable income is wrong,” Tony Salgado, president and founder of AMS Wealth, said in an interview with BNN Bloomberg Monday.
Contributions to RRSPs, on the other hand, are tax-deductible.
“Look at your own personal marginal tax rate to assess whether an RRSP or TFSA is going to fit your profile,” Salgado said.
“A tax deduction is only as good as your taxable income. If you make $10-$40,000 a year, the benefit you’re going to receive from a tax deduction will be insignificant compared to someone who makes $250,000 a year.”
If you opt for RRSPs, Salgado said it’s important to recognize that your financial situation, and the tax bracket you belong to, will change over time.
“If you go down the path of RRSPs, be mindful of when you’re going to make use of [your contributions]. If your marginal tax rate today is 20 per cent and you’re deducting tax contributions, and tomorrow your marginal tax rate is 50 per cent and you’re withdrawing, there’s a tax leakage of 30 per cent. So that’s not a good plan for somebody,” he said.
“So not only do you have to appreciate the value of each option today, but determine and assess what position you are going to be in in the future when you make use of the money.”
When it comes to saving for specific goals, the survey also revealed mixed views on whether it was more ideal to use a TFSA or an RRSP.
Most respondents said they believe an RRSP is a better choice for retirement savings (61 per cent). That compares with 22 per cent who said TFSAs are better.
When saving for home renovations, 55 per cent of the Canadians surveyed said they prefer a TFSA, while 13 per cent said they favour the RRSP.
When it comes to saving for a down payment on a first home, 41 per cent said a TFSA is the best choice, compared with 25 per cent who said an RRSP is the better option.
The survey also showed Canadians are unsure how the two savings vehicles impact their taxes. Thirty-five per cent of respondents said they don’t understand the tax implications of a TFSA, while another 30 per cent said the same when it comes to an RRSP.
TD’s findings are based on an Ipsos poll of 1,500 Canadians aged 18 and over, conducted online in December on behalf of the bank. The margin of error is plus or minus 2.9 per cent.