- Canadian Tax Shelters - Ivan Melenchon
If you are Canadian, you have easy access to two different tax shelters. One is the Registered Retirement Savings Plan (RRSP), and the other is the Tax Free Savings Account (TFSA).
Furthermore, if you, like most Canadians, are not able to contribute the maximum amount to both, you need to make a decision as to which tax shelter is best for you.
Over the years, the circumstances of your life will change, as will government regulations regarding taxes, savings and tax shelters. And so, it is incumbent upon you to make your best educated guess as to whether your savings belong in an RRSP or a TFSA, or what portion of your savings belong in each.
Basics of the RRSP
The basic idea of an RRSP is to defer taxes until you retire. It's assumed that retired Canadians earn less money than they did while employed. At seventy-one, you must close out your RRSP account. Most people will transfer their RRSP to a Registered Retirement Income Fund (RRIF). At that point, they must begin to withdraw money and pay income tax.
The inaugural year of the RRSP was 1991. The amount you can contribute each year is based on earned income in the previous year. If you didn't contribute your maximum in one year, it accrues into the next.
There's a contribution ceiling. The maximum contribution in 2011 is $22,450. However, if you have a carry forward that has existed for several years, the amount of money that you can put into your RRSP in 2011 may be over this amount. The Canadian Revenue Agency (CRA) annually provides details regarding your contribution room. The amount is found on your Notice of Assessment.
You have, until the end of February, to put money into your 2011 RRSP allowable contribution. But, make sure you don't put more money into your RRSP than your allowable amount. Because, after a $2,000 permissible overage, CRA will charge you a fee of 1% per month.
If you've had an employer over the past year, you've been paying income tax. Because an RRSP is a tax deferred plan, when you claim you RRSP contribution, taxes paid on that income will be refunded.
Early RRSP Withdrawal
If you take money out of your RRSP investment account, at the time of withdrawal, you must pay the income tax. But, there are a few exceptions to the rule. For example, if you are a first time homebuyer, you can take money out of your RRSP to put toward a down payment. But, you must gradually put the money back into your RRSP account.
Basics of the TFSA
The first year the TFSA was available was 2009. The maximum amount a person can put into this account each year is $5,000, and is not contingent upon income. However, as time goes on the federal government may increase the amount, depending on inflation.
With the TFSA, you've already paid income on your investment. And, you can continue putting the allotted amount into the account past the age of seventy-one. Also, when you take money out, there is no penalty. After all, the taxes have already been paid.
What you're not paying taxes on is the capital gains, which can be quite a bit of tax free money. If an individual invested $5,000 each year the program has exited, thereby accruing $15,000 in mutual funds, it would not be far fetched to have $2,000 in tax-free money by 2012.
Like an RRSP, the amount you can contribute each year accrues. If you haven't made any contributions to a TFSA, in 2012, you would be allowed a $20,000 tax shelter.
Although you can withdraw money without penalty, it would be a mistake to use your TFSA as if it were a checking account. Because, if you put more than $5,000 in a TFSA over the year, CRA would charge you 1% per month for any amount over $5,000.
For example, let's say, in 2009, Susan put $5,000 in her TFSA. Then she withdrew $3,000 to go on vacation. Her vacation plans fell through. She put the money back into her TFSA. This means she contributed $8,000 to her TFSA and will have to pay a penalty.
If Susan had waited until 2010, to put the $3,000 back into her TFSA, she would not have been penalized.
Which is the Better Tax Shelter?
So, you have $5,000 to put into an RRSP or a TFSA, which should you, chose? The complicated, and truthful answer is; it depends. The short answer is; an RRSP is money put aside for retirement and, in general, should remain invested until retirement. A TFSA is for all other savings investments.
Sources
City News - Toronto - 7 tips for your tax-free savings account
Investor Education Fund - A Canadian Non-Profit Organization
Canada Revenue Agency - Tax Free Savings Accounts for Individuals
Canada Revenue Agency - How Much Can I Contribute and Deduct to an RRSP
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