One of the most common questions we are asked by clients is whether they should be contributing surplus funds to a TFSA or an RRSP. This is a broad question, as the right decision varies greatly from person to person, and requires an understanding of the individual’s needs and goals.
Firstly – Avoid over contributing!
When delving into the world of RRSP and TFSA contributions it is easy for some tax payers to get carried away with attempting to save on tax, those who overcontribute above their allowable limit are hit with over contribution penalties by CRA, resulting in zero tax savings as a result. Before making contributions to either a TFSA or RRSP account please ensure you review your online CRA account or most recent Notice of Assessment to identify your contribution limit for that tax year. Only contribute amounts within your limit to avoid penalties!
How does your RRSP limit increase?
If you do not contribute to an RRSP account you will notice an increase in your contribution limit over time. Failure to contribute in a tax year does not result in ‘missed out’ contribution, as the unused limit is carried forward to future years. For the vast majority of tax payers, the RRSP contribution room is increased by 18% of their earned income from the prior tax year.
For example. John from Vancouver earned $100,000 in 2020, he has never made a contribution to an RRSP. The increase to his RRSP contribution limit will increase by $100,000 x 18% = $18,000 for the 2021 period. This $18,000 will be added to his carried forward limit from 2020.
How does your TFSA limit increase?
Similarly to the RRSP limit mentioned above, failure to contribute to a TFSA account during a tax year does not result in that contribution room being ‘missed out’, unused balances are carried forward to future periods. The annual increase to TFSA contributions is advised by CRA each year, and is the same for every tax payer. It is not based on an individual’s income levels.
For example. Sharon from Victoria had unused TFA contribution room of $50,000 at the start of 2020, CRA advised that the additional TFSA limit being added for 2021 was $5,000, this means Sharon is able to contribute $55,000 to a TFSA account in 2021 without being penalized.
RRSP deduction – Receive a tax refund
When contributing to an RRSP account tax payers are eligible to claim a deduction on their tax return for the amount of the contribution (as long as it is all within their limit). This allows for an individual to be refunded for tax paid on the amount of the contribution at their highest marginal rate of tax being paid.
The main theory behind contributing to an RRSP is that you are refunded for tax being paid at a higher rate while you are earning higher levels of income during employment, then when you receive the funds out of your RRSP account during retirement and recognize those funds as income you are then hit with tax at a lower rate, as you will be in a lower tax bracket during retirement. With an RRSP you are essentially deferring tax until retirement at which point you will be in a lower tax bracket.
There are no deductions allowable for TFSA contributions, however you can withdraw funds from a TFSA on a tax free basis.
RRSP contribution timing
Tax payers are eligible to claim deductions for RRSP contributions made during the tax year, including up to February 28 of the following tax year. For example, Arash from Kelowna contributed $10,000 to his RRSP during the 2022 tax year, he also contributed an additional $2,000 before February 28, 2023, Arash is eligible to claim the full $12,000 deduction on his 2021 tax return, even though $2,000 was contributed in 2022. (He can only claim the $2,000 deduction in one tax year, he can choose whether to claim the deduction in the 2021 or 2022 tax period)
Unsure of the implications of your RRSP and/or TFSA on your tax return?
There are a lot of pros and cons with regard to choosing a TFSA or RRSP, and there are a lot of additional discussion points including the home buyers plan associated with the RRSP, or the option to choose a self-directed TFSA to avoid potentially unlimited levels of capital gains taxes. If the topic is too overwhelming, or you do not know how to account for your TFSA or RRSP on your tax filing, please do not hesitate to contact the JTB team at email@example.com . At the time of posting our Vancouver office is not open for walk in consultations. We are continuing to handle all tax filings over email correspondence as usual.