TFSA or RRSP? It depends what you’re saving for
Posted November 28th 2013
Retirement savings decisions were a whole lot simpler before 2009. In those days, aside from your company pension (if you were lucky enough to have one), there was only one retirement savings option: a Registered Retirement Savings Plan (RRSP).
This retirement savings option allowed you to put away some of your after-tax earnings to create non-taxable investment income, while also taking a bite out of your tax bill. In fact, an RRSP is such an effective savings vehicle, it often makes sense to borrow from the bank to contribute to an RRSP; while you’re paying off the principal and interest, you can get a third (or more) of that back on your income tax return.
Then, on January 1, 2009, the federal government threw us a curve in the form of the Tax Free Savings Account (TFSA). Now, with another retirement savings option, how do you choose?
It’s not a simple choice, but if you have a clear idea of your savings goals, the decision becomes easier.
Start with the essential differences between a TSFA and an RRSP: the TFSA isn’t tax-deductible, so it doesn’t pay off this tax season, while an RRSP shows an immediate impact on your tax return. But the savings and interest on your TSFA aren’t considered income when you withdraw money. If you do withdraw money from your RRSP, it is considered income for tax purposes and you lose the contribution room.
A TFSA can be attractive for a shorter-term savings goal – a down payment on a car or home, for example – or as an emergency fund. An RRSP gives you some tax shelter today while you’re saving for your retirement.
A few other differences:
- The annual contribution limit for a TSFA is much lower than for an RRSP. This year, the TSFA ceiling is $5,500, but the RRSP limit is 18% of earned income up to $23,820 – unless you haven’t contributed in the last few years, in which case the contribution ceiling could be much higher.
- When you hit age 71, your RRSP accounts must be converted to cash or an income-bearing fund like a Registered Retirement Income Fund (RRIF). You can leave money in your TSFA forever, and you don’t pay tax on the withdrawals.
- It’s important to remember that RRSP or RRIF income is taxable and together with other pension incomes. So if your annual income is $71,000 or more, the government starts clawing back Old Age Security (OAS) benefits, and at a harsh rate.
- It’s not an either/or discussion. You can hold both RRSPs and TFSAs. And if you don’t have the funds to contribute to your RRSP, you can withdraw from your TFSA to make the contribution.. Just remember, contributions to both vehicles are monitored by the Canada Revenue Agency (CRA), and over-contributions to either can be penalized.
It’s good to have choices, and ultimately taxpayers benefit from the addition of TFSAs, but because the two savings vehicles have significantly different tax implications, ensure you understand the specifics of each before deciding to climb on board.
If you need more information about RRSPs, TFSAs and how they can help you save for retirement or other goals, visit one of our offices and ask a tax professional.
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