In Canada, the Registered Retirement Savings Plan (RRSP) and the Tax-Free Savings Account (TFSA) are two savings plans made available by the federal government to help Canadians put away money for retirement in tax-advantaged investments. While technically it is possible to transfer funds from your RRSP to your TFSA, it is not advisable to do so given the nature and the rules of both the RRSP and the TFSA.
Features of an RRSP
You can invest in an RRSP when you have taxable earned income from a job. Your contributions, up to prescribed maximums, are deductible from taxable income, and the investment income generated inside the plan is not subject to income tax. You pay income tax only when you withdraw money from the plan, typically upon retirement when you generally find yourself in a lower tax bracket due to lower income.
Features of a TFSA
Since Jan. 1, 2009, the government has allowed any Canadian with a Social Insurance Number (SIN) to invest up to $5,000 per year in a TFSA. The contribution is not tax-deductible, however, any interest earned inside the plan is not subject to income tax, and any withdrawals, including interest withdrawals, are also not subject to income tax. Any unused portion of the $5,000 annual contribution limit can be carried forward to future years indefinitely, going back to 2009.
Benefits of the TFSA
The TFSA is regarded as a complementary vehicle to the RRSP in that it allows investors to save more investment income tax even if they have maximized their RRSP contributions while having access to their funds without having to pay income tax on withdrawals. The TFSA's uses are not solely limited to tax saving and retirement income planning. A person wishing to save a particular amount of money for some later date, for example a down payment on a home, could invest in a TFSA, accumulate interest income not subject to income tax and make subsequent withdrawals not subject to income tax.
Transferring RRSP Funds into a TFSA
Individuals are not advised to transfer funds from an RRSP to a TFSA for two reasons: 1) The withdrawal from the RRSP is subject to income tax in the year it is taken, and 2) the TFSA has an annual contribution limit of $5,000, which would limit the amount of the transfer even when you take into account the contribution carry forward rule. In 2010, a Canadian who has not yet contributed any money to a TFSA has a contribution limit of $10,000 ($5,000 each for 2009 and 2010).
When to Consider a Transfer
The only time it makes sense to consider a transfer from an RRSP to a TFSA is in a year when you have no other sources of taxable income. In that case, due to the personal exemption afforded by the federal government, which stands at $10,320 for 2010, you could transfer $10,000 from your RRSP without any tax consequences and deposit the money into your TFSA where it would continue to earn tax-sheltered investment income. Only now, because the money is in a TFSA, would it be available for withdrawal in any subsequent year without being subject to income tax.
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