Can I Transfer RRSP Funds to a TFSA?

Moving funds between a Registered Retirement Savings Plan (RRSP) and a Tax-Free Savings Account (TFSA) is not a direct, tax-free transfer. Instead, it involves an RRSP withdrawal, which has tax implications, followed by a contribution to the TFSA. This article clarifies how funds can be moved between these accounts and outlines key considerations.

Understanding RRSPs and TFSAs

Registered Retirement Savings Plans (RRSPs) are designed primarily to help Canadians save for retirement. Contributions made to an RRSP are tax-deductible, meaning they can reduce your taxable income in the year they are made. Investments held within an RRSP grow on a tax-deferred basis, which means no taxes are paid on the investment income or capital gains until funds are withdrawn, typically in retirement. All withdrawals from an RRSP are considered taxable income at the time they are taken out.

Tax-Free Savings Accounts (TFSAs) offer a different approach to saving, suitable for a variety of financial goals beyond just retirement. Contributions to a TFSA are not tax-deductible, meaning they are made with after-tax dollars. The significant advantage of a TFSA is that any investment income earned within the account, including interest, dividends, and capital gains, is completely tax-free, and all withdrawals are also tax-free. This makes TFSAs highly flexible for both short-term and long-term savings.

Both RRSPs and TFSAs have specific contribution limits. For RRSPs, your contribution room is generally 18% of your earned income from the previous year, up to an annual maximum, plus any unused contribution room carried forward from prior years. TFSA contribution room accumulates annually from the year you turn 18, provided you are a Canadian resident, and includes any unused room from previous years and the total amount of withdrawals made in the previous year.

Executing the Fund Transfer

Moving funds from an RRSP to a TFSA is not a direct, seamless transfer but rather a two-step process that begins with an RRSP withdrawal. To initiate this, you must contact your financial institution where the RRSP is held and request a withdrawal. Your institution will require you to complete specific forms, and it is important to confirm any associated fees or processing times.

Once the funds are withdrawn from your RRSP, they become available for contribution to your TFSA. You can contribute these funds to your TFSA through various methods offered by your financial institution, such as electronic transfers, cheque deposits, or in-person transactions. It is important to ensure you have sufficient TFSA contribution room available before making this deposit to avoid over-contribution penalties.

Tax Consequences of the Transfer

Withdrawing funds from an RRSP has immediate tax implications, as the withdrawn amount is considered taxable income in the year it is received. Your financial institution will typically withhold a portion of the withdrawal as a prepayment of taxes, with the withholding tax rate varying based on the amount withdrawn. This withheld amount is sent directly to the government.

The full amount of the RRSP withdrawal must be reported on your income tax return for that year and will be added to your total income, potentially increasing your marginal tax rate. This could result in a higher overall tax liability than the amount initially withheld, requiring you to pay additional taxes. Withdrawing funds from an RRSP does not regenerate that RRSP contribution room; once withdrawn, that room is permanently lost.

When these withdrawn funds are subsequently contributed to a TFSA, they utilize your available TFSA contribution room. While TFSA contributions are not tax-deductible, any amount contributed counts against your current year’s TFSA limit. If you withdraw funds from a TFSA, that contribution room is restored in the following calendar year, allowing you to re-contribute the withdrawn amount. This regaining of contribution room applies only to withdrawals made directly from a TFSA.

Evaluating the Transfer Decision

Before moving funds from an RRSP to a TFSA, individuals should carefully assess their personal financial situation and future goals. A primary consideration is your current income level; withdrawing from an RRSP in a year with low income can be advantageous, as the withdrawal will be taxed at a lower marginal rate. Conversely, making an RRSP withdrawal during a high-income year could push you into a higher tax bracket, resulting in a substantial tax bill.

Consider your expected future income. If you anticipate lower income in retirement, keeping funds in the RRSP to defer taxes until then might be more beneficial. The availability of TFSA contribution room is another practical factor, as you must have sufficient room to accommodate the funds you intend to transfer. Understanding your financial goals, such as saving for a down payment or increasing accessible tax-free savings, will also guide this decision.

While this transfer can offer greater flexibility and tax-free access to funds in the TFSA, the immediate tax cost and permanent loss of RRSP contribution room must be weighed against these benefits.