While Registered Retirement Savings Plans and Tax-Free Savings Accounts both have benefits, deciding where to put your money depends on your own personal situation. Before investing in either of these savings plans, it’s important to know the differences.
Tax-Free versus Tax Deferred
TFSA’s are tax-free. This means that you can contribute up to the maximum limit without any tax implications when you withdraw the funds.
Contributions to your RRSP are tax-deferred. You’ll pay tax on the contributions and earnings when you either withdraw the funds pre-retirement or when you retire and begin to receive your monthly payouts. If you leave the funds in your RRSP until you do retire, chances are you’ll be earning less income than when you were working and face a lower rate of tax. Pre-retirement withdrawals are taxed rather heavily as the whole point of RRSP’s is to leave the funds in the retirement account until you actually retire.
If you plan on withdrawing your investment before retirement, TFSA’s might be the better option for you.
Income tax Deductions
Contributions to your (or your spouse’s) RRSP are deductible on your annual tax return. While the deduction does not translate to an income tax refund on its own, it can help to lower your tax payable. Contributions come off your gross income dollar for dollar, dropping your taxable income which is the amount you pay tax upon.
TSFA contributions yield no tax deduction on your annual tax return.
If you’re looking for the added benefit of a tax deduction, RRSP’s might be best for you.
RRSP’s have a few extras that may appeal to you. Funds contributed to RRSP’s can be withdrawn in two special situations without penalty – the Home Buyer’s Plan and the Lifelong Learning Plan. Both of these plans allow you to withdraw your contributions and repay the amounts over time. If you’re looking to purchase your first home, you can withdraw up $25,000 from your qualifying RRSP contributions without penalty and then repay the withdrawal back into your RRSP account over the next 15 years. Similarly, the Lifelong Learning Plan allows taxpayers to withdraw up to $10,000/year for two years to pursue full-time training or education for you or your spouse. The designated repayment period for an LLP is ten years.
TFSA’s don’t have extra options. It’s as simple as contributing and withdrawing within the limits.
If you’re unsure about which savings plan is best for you, think about why you’re saving. If the money is strictly for something like a cottage or a boat, TSFA’s are likely the right choice for you. If you’re committed to your retirement or planning on going back to school or buying your first home, RRSP’s might be better. And you’re not limited to one or the other. Many taxpayers do both. Consider contributing enough to your RRSP to garner a tax refund. Then contribute your tax refund to your TFSA. This plan delivers the best of both worlds – the security of a retirement nest egg with your RRSP and the flexibility to withdraw penalty-free from your TFSA. It’s the best of both worlds.