Tax-Free Savings Accounts (TFSAs) are a relatively new way to save money. Registered Retirement Savings Plans (RRSPs) have been around for quite a while. Many people, though, especially youth, wonder which savings product is better.

Getting Started

Appropriate Subject Area(s):

Personal finance, money, saving, math, social studies

Key Questions to Explore:

  • What is a TFSA?
  • What is an RRSP?
  • How does a young person decide which is the best savings product to use?
  • How might a person’s decision differ according to age and income?

New Terminology:

The generation of people born during the 1980s and early 1990s. The name is based on Generation X, the generation that preceded them. Members of Generation Y are often referred to as “echo boomers” because they are the children of parents born during the baby boom (the “baby boomers”). Because children born during this time period have had constant access to technology (computers, cell phones) in their youth, they have required many employers to update their hiring strategy in order to incorporate updated forms of technology.  Also called millennials, echo boomers, internet generation, iGen, net generation.

  • Withholding tax
  • After-tax dollars
  • Carry forward
Study and Discussion Activity

Introduction to the Lesson and Task:

One goal everyone has is to minimize the taxes paid on income earned. A key distinction for students to understand is the difference between “tax avoidance” and “tax evasion.” Tax avoidance is making sure you do not pay any more in taxes than you need to pay. Tax evasion is when you do not pay taxes that you should pay – which is illegal.

Tax avoidance, though, is perfectly fine and something that everyone should try to do since, although all should pay their fair share, no one should pay more than they are supposed to. To avoid taxes includes making sure that you take advantage of all the products and tools that can help you minimize your taxes. Two such products are Registered Retirement Savings Plans (RRSPs) and Tax Free Savings Accounts (TFSAs).

What is an RRSP? (From the Investor Education Fund web site)

A Registered Retirement Savings Plan (RRSP) is an account, registered with the federal government, that you use to save for retirement. RRSPs have special tax advantages:

  1. Tax-deductible contributions – You get immediate tax relief by deducting your RRSP contributions from your income each year. Effectively, your contributions are made with pre-tax dollars.
  2. Tax-sheltered earnings – The money you make on your RRSP investments is not taxed as long as it stays in the plan.
  3. Tax deferral – You’ll pay tax on your RRSP savings when you withdraw them from the plan. That includes both your investment earnings and your contributions.

Note that you can take money out of an RRSP but, when you do, taxes will be deducted from your withdrawal (“withholding tax”). Recall that, when you put money into an RRSP, you get a tax deduction up to a certain amount.  Therefore, taxes were avoided.  When you take the money out of the RRSP, the taxes have to be paid. Some will be withheld at the time of your withdrawal. Depending on your income and tax rate, more taxes may be due on your withdrawal at tax time.

Each year you will have a certain amount that you are allowed to contribute to an RRSP to get a tax deduction. If you do not make your full allowable contribution in the year, you can carry-forward the unused amount to the next year.  As a simple example, if you could contribute $5,000 this year and you contributed $3,000, you can carry over $2,000 to the next year. So, if next year you are allowed $5,000, with the $2,000 carried forward, you can actually contribute $7,000 and get a larger tax deduction.

What about a TFSA?

Once again, from the IEF’s website:

Tax-free savings accounts (TFSAs) are designed to help Canadians save more. 

Nine things to know about TFSAs

  1. TFSAs are available to Canadians age 18+. 
  2. As of January 1, 2013, you can contribute up to $5,500 each year. If you don’t contribute the full amount each year, you can carry forward the unused amounts, based on the contribution limits for each year. From 2009 to 2012, the contribution limit was $5,000 per year.
  3. You can save tax free for any goal you want (car, home, vacation).
  4. You don’t need earned income to contribute.
  5. You don’t have to set up a TFSA or file a tax return to earn contribution room.
  6. You can take money out when you want, for any reason, without paying any tax.
  7. If you take money out, you can re-contribute it the following year, in addition to the annual $5,500 maximum. Re-contributions for 2009 to 2012 are based on the previous $5,000 contribution limit.
  8. You can hold a wide range of investments in a TFSA, like cash, GICs, bonds, stocks and mutual funds.
  9. You can put money into your spouse’s or common-law partner’s account.

You can put money in at any time, up to set limits. You can take money out at any time, without paying any tax.

The main difference between an RRSP and TFSA is the timing of taxes:

  • An RRSP lets you defer taxes – an advantage if your marginal tax rate is lower in retirement.
  • With a TFSA, you’ve already paid tax on the money you contribute – an advantage if your marginal tax rate is higher when you withdraw the money.

Many young people hear or learn about these two financial products and struggle to understand which is best for them, something many older Canadians also struggle with. The article helps to shed some light on how to make the decision, as does the additional material provided in the lesson plan.

Action (lesson plan and task)

  • Provide students with a copy of the article in advance of the class and ask them to read about RRSPs and TFSAs and be prepared to come to the next class able to discuss the difference.
  • Prior to the next class, use the material provided here – and other material you may draw upon – to prepare a handout for students explaining what RRSPs and TFSAs are and what the differences are.
  • At the beginning of the next class, solicit answers from students to the questions: What is an RRSP? What is a TFSA? What are the key differences?
  • Provide students with a copy of Handout #1 and any other Handout materials to accompany the article previously distributed.
  • Divide the class into four groups. Assign each group one of the profiles provided on Handout #2 or create one or more profiles of your own. Ask each group to discuss which would be best for them – an RRSP, a TFSA, or both – given their personal profile.
  • Provide time for students to begin their discussion. Provide them time until the next class to make their decision and be able to explain why. Encourage them to involve family members in their discussion and group’s decision. Provide some time at the beginning of the next class for the groups to get back together, share other information they obtained, make a decision, and prepare their explanation. Ask each group to prepare a written summary that they can hand in.
  • Ask each group to report on their decision and explain why they made that decision.

Consolidation of Learning:

After each group reports, have a class discussion to review the decision and draw out key points that should help to guide future decisions that students will face.

Success and Additional Learning

Success Criteria:

Students should be able to:

  • Explain the key differences between an RRSP and a TFSA
  • Describe circumstances in which a person might be better off with a TFSA than an RRSP and vice-versa
  • Decide which would be best for them personally when it comes time, if that time has not already arrived, when they have money to save

Confirming Activity:

In a month or two, create four new Profiles and provide them to students with no advance preparation or warning.  Assign them to groups and ask them to make a decision as to what would be best to do with savings – RRSP, TFSA, or both – and share their decisions with the class.  See to what extent students have retained, and can apply, what was learned previously.