What the heck is the difference between RRSPs, TFSAs and RRIFs?
Understanding the money vehicles to deliver the best investing results:
So I was out last night for dinner with my good friend Lynette and the discussion moved towards finances, as it often does! She is awesome, a great HR Director, home owner, super personality, high energy and a great friend. She asked about the differences between RRSPs, TFSAs and RRIFs. So here is a primer:
Registered Retirement Saving Plan (RRSP) is an account that is regulated by the Canadian government that was introduced in 1957 to promote retirement savings. Within an RRSP account you can purchase a variety of investments like mutual funds, stocks, bonds, GICs etc… The beauty of the RRSP is that every year that you contribute you can deduct this amount from your total income – thus this is a tax shelter.
The major benefit of an RRSP account is that you will not have to pay taxes on any interest, dividends or capital gains that you earn inside the RRSP – until you take it out in retirement - more on that a bit later.
There are a few rules when it comes to RRSPs:
There is a contribution limit. The amount can change with each annual budget for 2017 the maximum contribution was 18% of your annual income or a maximum of $26.010.
If you have not maxed out your account (meaning if you have not contributed the maximum amount each year that you were eligible) you can catch up and contribute more than the $26.010 limit. How do you know? Check out your 2016 Notice of Assessment that you should have received after filing your 2016 taxes.
RRSPs are often also called a tax shelter, so if you make $75,000 a year in income, and you put in 18% into your RRSP ($13,500) your income was reduced to $61,500. When you retire and start to draw upon this funds you will have to pay taxes on this funds, The benefits is that when you are retired your tax rate will be lower.
When you turn 71 years young, you will have to convert your RRSP into a RRIF (registered retirement income fund) and begin to withdraw the funds.
If you are thinking about using some of these funds for a first time homeowner downpayment. You are permitted to withdraw $25,000 BUT you have to pay it back in 15 years. If you withdraw money for any other purpose there is a 20%- 40% penalty – so please use these funds as a last resort.
The Tax Free Savings Account (TFSA) was introduced in 2009 by the Canadian Government as a way to encourage Canadians to save more money. You can hold a variety of investment vehicles in this account such as Stocks, ETF, mutual funds, etc…
Here's what makes TFSAs awesome:
since the funds that you can use for this account is after tax, you don’t way a dime when you take funds out of this account.
all the interest you make in this account is tax free. So if you buy a stock in this account which cost you $1000 for the shares, and then stock has a good run and you $1000 turned into $50,0000 the $40,000 profit that you have earned is 100% tax free. Many people have become TFSA Millionaires – check out these stories here: http://www.moneysense.ca/save/investing/tfsa/the-biggest-tfsas-in-canada/
Unlike a RRSP, TFSA accounts are open and flexible, there is no penalty to withdraw funds
If you are retired, the money that you withdraw from a TFSA is not considered income so retirees can feel confident in taking out money from their TFSA without it affecting their retirement benefits like CPP/QPP, which decreased with higher income.
Here are the TFSA rules:
In 2017 you are permitted to contribute a maximum of $5500 annually into this account.
You need to be 18 years old to open a TFSA account.
If you over contribute to this account, (see rule 1)you will be charged a penalty of 1% per month on the amount in your TFSA that is in excess of the limit.
Day trading in your TFSA is not permitted.
Registered Retirement Income Funds (RRIF) is similar to a RRSP, but as you read above the RRSP is a way to help you save money for retirement, and a RRIF is the vehicle to provide you with income during retirement.
Each person with an RRSP account will have to convert their RRSP into a RRIF or an annuity by the end of the year that you turn 71.
Here’s what you need to know about RRIFs
Once you are 71 years young, the Canadian government requires that you take out a minimum every year. The amount is determined by your age, so if you are 75, you can take out 5.82%, if you are 90, you can take out 11.92%
You will need to close your RRSP account and convert it into a RRIF your investment as will continue to grow into a RRIF
The money that you withdraw is income so there will be taxes to pay.
Yes this is a lot to take in. Hope that this shed some light on these tax saving financial items that can help you save for today and for tomorrow.