Is There an Equivalent to the Roth IRA in Canada?

Thinking of crossing the border for your retirement? You’re not alone. Every year, thousands of Americans retire to Canada in search of a better quality of life. But despite the many similarities between the two countries, there are also some key differences – especially when it comes to retirement planning.

One particularly challenging detail for many people is finding an equivalent to the Roth IRA in Canada. This type of individual retirement account is hugely popular in the United States, and its closest match across the border is the TFSA. But how do these two accounts compare, and which one is right for you?

Roth IRA vs TFSA

While both the Roth IRA and the TFSA are retirement savings vehicles, there are some obvious differences between them. Whether one is better than the other depends on your individual circumstances as well as your retirement savings and goals.

Contribution Limits

In 2021, the contribution limit for a Roth IRA is $6,000 (or $7,000 if you’re 50 or older, with $1.000 as a catch-up contribution). For a TFSA, the limit is $6,000 regardless of your age.

In spite of the same contribution limit, retirement in Canada with a TFSA offers a much more flexible contribution schedule. Namely, it allows you to carry forward any unused contribution room from previous years, whereas the Roth IRA does not.

For instance, let’s say you didn’t contribute to your IRA account in 2020. In 2021, you would only be able to contribute $6,000. In contrast, if you didn’t contribute to your TFSA in 2020, you would be able to contribute $12,000 in 2021 (the sum of the $6,000 contribution limit for 2020 and the $6,000 sum for 2021).

Traditional IRAs

The Roth IRA has its roots in the traditional IRA, which allows you to make tax-deductible contributions. With a traditional IRA, you’re taxed on your withdrawals in retirement, but with a Roth IRA, your contributions are made with after-tax dollars, and your withdrawals in retirement are tax-free.

Those looking for a traditional IRA in Canada will be disappointed to learn that there’s no direct equivalent. However, there are some retirement accounts that offer similar tax benefits, such as the TFSA.

Defined Contribution Plans

A defined contribution plan is a type of retirement savings plan in which both employees and employers make contributions. The most common type of defined contribution plan in the United States is the 401(k). It’s an employer-sponsored retirement savings plan that offers significant tax benefits.

On the other hand, retirement planning in Canada is done primarily through Registered Retirement Savings Plans (RRSPs). Like the 401(k), RRSPs offer tax breaks on contributions, but they work a bit differently. With an RRSP, the contributions are tax-deductible, and the withdrawals are taxed as income in retirement.

IRA Contribution Age and the SECURE Act

Under the Setting Every Community Up for Retirement Enhancement (SECURE) Act, which was passed in 2019, the age for required minimum distributions (RMDs) from a traditional IRA was raised from 70 1/2 to 72.

Among pension plans in Canada, the TFSA has no age limit for contributions, which is one of its key advantages. In other words, if you’re over the age of 72 and still working, you can continue to contribute to your TFSA.

Withdrawals and Taxes

Withdrawing funds from an RRSP account is possible at any given time. Any transactions will be classified as taxable income, which will be subject to the marginal tax rate. Once the taxpayer turns 71, the funds must be cashed out and transferred to a Registered Retirement Income Fund (RRIF), where they will continue to grow tax-free.

As for the Roth IRA, contributions are completely tax-deductible and capital gains are tax-deferred. This means that you won’t have to pay any taxes on your withdrawals as long as you follow the rules (i.e., wait until you’re 59 1/2 years old and have had the account for at least five years).

Government Pensions

The Roth IRA equivalent in Canada, the TFSA, has no effect on government pensions. In other words, your TFSA balance will not be taken into account when determining your eligibility for government benefits such as Old Age Security (OAS) or the Guaranteed Income Supplement (GIS).

The former is a monthly pension paid to seniors by the federal government, and the latter is a supplement for low-income seniors who are also receiving the OAS. Both are considered to be part of the Canadian social safety net.

The OAS also implements the clawback provision, which is a policy that allows the government to recoup some of the benefits paid out to seniors with high incomes.

Taxation of Roth IRA vs TFSA

All contributions you make to your Roth IRA are made with after-tax dollars, which means you won’t get a tax deduction when you contribute. However, all of your withdrawals in retirement will be completely tax-free as long as you’re 59 1/2 years old and you’ve had the account for at least five years.

The Canadian Roth IRA, or the TFSA offers similar tax benefits. Your payments don’t get a tax break when you contribute, but all of your withdrawals are tax-free. So if you’re looking for a retirement savings plan that offers tax-free growth and withdrawals, the TFSA is a good option.

Advantages of TFSAs Over Roth IRAs

If you’re interested in the ways that the TFSA can benefit you in retirement, there are a few key advantages that it has over the Roth IRA.

Ability to Carry Over Contributions to Future Years

One of the biggest advantages of the TFSA is that you can carry over your unused contribution room to future years. This means that if you don’t contribute the maximum amount for one year, you can make up for it in subsequent years.

With a Roth IRA, on the other hand, you can only contribute the maximum amount for each tax year. If you don’t contribute the full amount, you can’t make up for it later on.

Qualified Distributions

Another advantage of the TFSA is that all of your withdrawals are considered to be “qualified distributions.” This means that they’re not subject to any penalties or taxes.

With a Roth IRA, on the other hand, only certain withdrawals are considered to be qualified. If you withdraw money before you’re 59 1/2 years old, you may be subject to a 10% early withdrawal penalty.

Retirement in Canada vs the USA

Retirement plans in the United States and Canada offer numerous benefits to senior citizens. In both countries, retirees can enjoy tax-free growth on their investments and tax-free withdrawals in retirement.

The Canada Pension Plan (CPP) is a program that provides a monthly pension to seniors who have worked in Canada for at least 10 years. The amount of the pension is based on the contributor’s earnings and the number of contributions throughout the years.

The Social Security program is the equivalent of the CPP in the United States. It’s sponsored by the federal government and provides benefits to retired workers and their spouses. The amount of the monthly benefit is based on the worker’s lifetime earnings.

One of the main benefits of pension plans in Canada is the healthcare system. All residents have access to universal healthcare, which means that seniors can receive free or low-grade medical expenses.

In the United States, on the other hand, the circumstances are different. While there are some government-sponsored health insurance programs, such as Medicare, not all seniors have access to them nor are they free.

Finishing Thoughts

All thing’s considered, the TFSA is more than a decent equivalent to the IRA account in Canada. It offers many of the same benefits, such as tax-free growth and withdrawals, and it has a few key advantages, such as the ability to carry over unused contribution room to future years. So why not start saving for your retirement with a TFSA today?