Roth IRA Canada vs TFSA vs Other Retirement Accounts Compared

Canadians and Americans ride on a similar investment vehicle, which is one of many ties that bound them.

However, the US retirement accounts (401(k) and Roth IRA) differ from those of Canada (RRSP and TFSA).

So if you’re a Canadian resident and are working in the US, you may be contemplating Roth IRA vs. RRSP vs TFSA.

This begs the question: Is a Roth IRA equivalent to TFSA? Can I have both a Roth IRA, 401(k), TFSA and RRSP? Is it better to retire in Canada or the US?

Here I answer these questions and lots of other related questions to help you make informed decisions on your retirement savings.

Roth Canada: Understanding US and Canadian Retirement Accounts

The ties between the US and Canada don’t require an introduction. From entertainment, politics, US pop culture to education – it’s so obvious to see.

But when it comes to retirement services, it is essential to understand how the two countries differ.

As a result, we shall be discussing 401k vs Roth IRA vs RRSP vs TFSA as the basis of understanding the similarities and differences between the US retirement accounts vs. Canada’s.

What is 401K Canada?

Popularly known as a 401(k) plan, this is a tax-free retirement account provided by US employers to their employees.

Regardless of whether you’re residing in the US or Canada, as long as you’re working in the US, you can open a 401(k) account.

That said, you can make automatic contributions to your 401(k) account through your paycheque.

Like the Canadian RRSP, 401(k) contributions are tax-free until withdrawal. However, there are penalties for early withdrawals.

Annually, the 401(k) plan contribution limit is adjusted to reflect inflation in the US. The following are the contribution limits for 2020 and 2021:

  • Employees under age 50: $19,500
  • Employees age 50 and above: $26,000+ $6,500 catch-up contribution.

Thus, this account is suitable if you think you will be in a lower tax bracket after retirement. But if you think your income will increase after retirement, Roth IRA is worthwhile.

But since no one is sure what tax rates will be decades from now, many financial advisers recommend opening both Roth IRA and 401(k) account.

Pros of 401K Canada

  • High contribution limits
  • Tax-free growth until withdrawal
  • Matching funds from an employer
  • Free investing advice

Cons of 401K Canada

  • Early withdrawal penalties (10%)
  • Higher account fees (in small companies)
  • Limited investment options

What is 401K Equivalent in Canada?

Now that you understand what the 401(k) plan entails, the next question is whether it has an equivalent in Canada.

Fortunately, the US 401(k) plan has an equivalent in Canada, which is RRSP.

Here we shall be discussing the similarities and differences between the 401(k) plan and RRSP.

What is RRSP?

The Registered Retirement Savings Plan (RRSP) is Canada’s tax-advantage retirement account.

Besides contributions, interest, capital gains and dividends in RRSP are tax-free.

Additionally, any interest or capital gains generated inside the RRSP are tax-free. However, RRSP withdrawals are considered income but are charged at a marginal tax rate.

Like the US 401(k), RRSP also has an annual contribution limit, the CRA maximum limit or 18% of your pre-tax income. For the 2020 tax year, $27,830 is the maximum limit set by the CRA.

Finally, you’re expected to convert your RRSP to RRIF when you turn 71.

Pros of RRSP

  • Tax-free growth until withdrawal
  • Spousal plan
  • Can be invested in different portfolios
  • Tax refund

Cons of RRSP

  • Withdrawal tax charges
  • Expiry date (at the age of 71)
  • Permanent loss of contribution room upon missing any
  • Strict withdrawal rules

Click here to learn more about RRSP and other retirement accounts in Canada.

What is a Roth IRA in Canada?

Popularly known as Roth IRA, this is a type of individual retirement account (IRA) with tax-advantage on contributions and withdrawal.

What I like about Roth IRA is that both contributions and withdrawals are tax-free, unlike 401(k) plan and RRSP.

However, Roth IRA has a 10% penalty for withdrawing earnings before age 59 ½. But exceptions apply on the following withdrawals:

  • Higher-education cost
  • Medical expenses
  • Permanent disability expenses
  • Health insurance premiums (due to being unemployed)
  • Inherited IRA
  • Home-related expenses
  • Substantially equal periodic payments (SEPPs)
  • Active duty as a military reservist or National Guard member
  • Unpaid taxes

That said, there may be federal and state taxes on the above exceptions for Roth IRA 10-early withdrawal penalties.

Finally, Roth IRA contributions are set annually. For 2021, Roth IRA maximum contribution limit is as follows:

  • Below 50 years old: $6,000
  • 50 years old and above: $7,000

Pros of Roth IRA

  • Tax-free contributions and withdrawals
  • Less restrictive
  • Flexibility
  • Tax diversification in retirement
  • No expiry date

Cons of Roth IRA

  • 10% penalty for earning withdrawal before age 59 ½
  • Low contribution limit
  • Income limit

What is Roth IRA Equivalent in Canada

I can guess that you’re now wondering whether there is a Roth IRA equivalent in Canada. Fortunately, there is.

Here we shall be discussing Canada’s TFSA account and how it relates to the Roth IRA.

What is TFSA?

TFSA stands for a tax-free savings account. It is the Canadian version of Roth IRA that allows you to make tax-free contributions and withdrawals.

With a TFSA, you can invest your money tax-free in any investment portfolio, and your income, capital gains, and dividends grow tax-free.

Since its establishment in 2009, TFSA has been an alternative savings account compared to traditional savings accounts in Canada due to its all-round tax relief.

Like Roth IRA, TFSA also has an annual contribution limit set by the Canada Revenue Agency. For 2021, the TFSA contribution limit is as follows:

  • $6,000 for 2021
  • $75,500 if you haven’t contributed to a TFSA since its inception (2009)

Notably, exceeding your TFSA contribution limit attracts 1% monthly charges on the added amount.

Pros of TFSA

  • Tax-free contributions and withdrawals
  • Flexibility (you can withdraw your money at any time).
  • Rolls over unused contribution rooms
  • Investment vehicle (you can also invest your money in any portfolio).
  • No expiry date

Cons of TFSA

  • Strict penalties for over-contribution (1% monthly interest)
  • No tax refund
  • Low contribution limit

To learn more about TFSA, click here.

Key Similarities and Differences Between 401(k) vs RRSP

Now that you know the major retirement accounts in Canada and how they relate with the US, let’s now examine their key similarities and differences.

1. Contribution Limits

As mentioned previously, the 401(k) plan contributions limit for 2021 is $19,500 (for employees under age 50) and $26,000 plus $6,500 catch-up contribution (for workers age 50 and above).

On the other hand, the RRSP contribution limit for 2021 is 18% of your pre-tax income or $27,830.

However, you can only contribute 18% to your TFSA account when you’re under the low tax bracket or if your pre-tax income is not more than $27,830.

As you can see, the contribution limit of 401(k) differs from that of RRSP. The RRSP contribution limit is not age-based. But you’re expected to convert your RRSP to RRIF when you turn 71.

However, the 401(k) contribution limit is age-based. Thus, you can contribute more or less according to your age.

2. Withdrawal Penalties

Both 401(k) and RRSP have withdrawal penalties. You are charged 10% for early withdrawal on a 401(k) account before age 59 ½ (with exceptions).

On the other hand, the following withdrawal charges apply on RRSP:

  • 10% for $5,000 early withdrawals
  • 20% for $5,001 and $15,000 early withdrawals
  • 30% for $15,000 and above early withdrawals

Similarly, RRSP has penalty exceptions for early withdrawals on:

  • Lifelong Learning Plan (LLP)
  • Home Buyers’ Plan (HBP)

Finally, when you make early withdrawals on RRSP, you forfeit your contribution room forever.

Key Similarities and Differences Between TFSA vs. Roth IRA

Both TFSA vs Roth IRA are all-round tax-free retirement accounts in the US and Canada. This implies that your contributions and withdrawals on these accounts are tax-free.

Here we look at the key similarities and differences and differences between Canada’s TFSA and the US Roth IRA.

1. Contribution Limits

Both TFSA and Roth IRA are all-round tax-free accounts with limited contribution limits.

The Roth IRA contribution limit for 2021 is $6,000 (for those under 50 years old) and $7,000 (for those 50 years old and above).

On the other hand, the TFSA contribution limit for 2021 is $6,000 old users and $75,500 for those that haven’t contributed to TFSA since its inception in 2009.

Notably, both TFSA and Roth IRA contribution limits are set annually by Canada Revenue Agency (CRA) and the US Internal Revenue Service (IRS).

3. Withdrawal Penalties

Whereas TFSA doesn’t have penalties on early withdrawals, Roth IRA has a 10% penalty for earning withdrawals before age 59 ½ (with exceptions).

To avoid Roth IRA earning withdrawal penalties, your withdrawal must be “qualified.” Qualified Roth IRA withdrawals refer to withdrawals that fall:

  • Within five years of creating a Roth IRA account.
  • Within the age of over 59½ years old.

On the other hand, TFSA has a 1% monthly penalty for exceeding contribution room. But you can avoid this by sticking to your annual contribution limit.

2. Flexibility

Both TFSA and Roth IRA allow you to withdraw your contributions tax-free at any time. Also, you can contribute to these accounts for your lifetime.

However, TFSA is more flexible than Roth IRA because it allows you to roll over your unused contribution room/limit to the following year.

For example, if you have never contributed to a TFSA since it started in 2009, you can make a tax-free contribution of up to $75,500 in 2021.

Retirement in Canada vs. US: Which is the Best?

So far, I have tried to explain the similarities and differences between Canada’s retirement accounts and US retirement accounts.

As a result, I discussed the similarities and differences between the US 401(k) account vs. Canada’s RRSP.

Furthermore, I discussed the similarities and differences between the US’ Roth IRA vs Canada’s TFSA, which are all-round tax-free accounts.

From my discussion, it is obvious to see why the US and Canada’s retirement accounts have much in common.

However, when narrowing your selection between 401(k), RRSP vs Roth IRA vs TFSA, there are two things to consider; contribution limit and withdrawal penalties.

While 401(k) and RRSP have high annual contribution limits compared to Roth IRA and TFSA, the withdrawal charges are not worthwhile.

Thus, you should consider a retirement account with a high contribution limit and less withdrawal penalties.

From all the above retirement accounts, only TFSA allows you to roll over your unused contribution room the following year, helping you save more tax-free.

Furthermore, only TFSA has less restrictive withdrawal rules. That’s a 1% monthly penalty for over-contribution. This is avoidable compared to Roth IRA’s 10% earning withdrawal penalties before the age 59 ½.

Overall, I will recommend TFSA over Roth IRA. But if you are more concerned about a high contribution limit, consider RRSP. However, you can have both a TFSA and RRSP account at the same time.

Final Thoughts on Canadian Roth IRA

At first, it may seem challenging to choose between Canada’s retirement accounts versus the US’. But you can see how simple it is now.

On both sides of the comparison angles, Canada’s retirement accounts weigh high against the US retirement accounts.

Specifically, you should consider a TFSA account over any other retirement accounts if you’re after a high contribution limit and less withdrawal penalties.

But if you’re looking for a retirement account with a high contribution limit, RRSP is my recommendation.

Let me know in the comment section which retirement account you’re opening.

FAQs on Roth IRA in Canada

Can I Hold a Roth IRA and 401k Account Simultaneously With Canada’s RRSP and TFSA?

Yes, so long as you’re working in the US, you can hold both the US retirement accounts (Roth IRA and 401(k)) and Canada’s retirement accounts (RRSP and TFSA).

However, it’s cost-effective to narrow your selection since Roth IRA and TFSA are the same, whereas 401(k) and RRSP are also the same.

What is Better TFSA or RRSP?

It depends on what you’re looking for. If you’re looking for an all-round tax-free retirement account without regard to the contribution limit, TFSA is better.

But if you’re more concerned about contribution limits without regard to withdrawal penalties, RRSP is better.

To make an informed decision, read this comprehensive comparison between TFSA and RRSP.

Is Roth IRA Taxed in Canada?

Yes. According to the Canada Revenue Agency, Roth IRA is subject to income tax because the retirement account doesn’t have income tax deferral.

If you have more questions on Roth IRA in Canada, let me know in the comment section.

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