RRSPs (Registered Retirement Savings Plans) and TFSAs (Tax-Free Savings Accounts) both offer tax advantages to help you reach your retirement or savings goals. Reducing taxable income (with RRSPs) and accumulating tax-sheltered compound returns over the long term (both RRSPs and TFSAs) can be a powerful combination. A good strategy is to contribute to both as much as possible, if you can afford it.
If you choose one or the other, it’s important to understand how they differ.
RRSPs are intended for retirement, and you need to earn income to contribute. When you contribute to an RRSP, you deduct your contribution from the income you report on your tax return. If you have a small tax bill each year, RRSPs may not make sense for you. When you decide to withdraw money from your RRSP, the amount withdrawn gets added to your income in the year the money is taken out. However, all the growth made inside the RRSP compounds tax-free. RRSP contributions work great if you are withdrawing at a similar or lower marginal tax rate compared to the contribution. If you are withdrawing at a higher tax rate at retirement, an RRSP is probably not a good choice.
TFSAs were created as a way to encourage Canadians to invest and save without paying taxes on interest gained. Your savings can be used for any type of savings goal, which may be more attractive to young savers who want to have an accessible emergency fund or save up for a large purchase like a car or vacation. With a TFSA, you cannot deduct your contribution on your tax return and do not have any taxable implications on withdrawal. There are annual limits on how much you contribute, and if you don’t use up that room, it can get carried forward to subsequent years.
With both plans, you can name your spouse as a beneficiary, and the money will roll over to them upon your death. With a TFSA, only the increase in the value of the TFSA since the date of death is taxed in the year the beneficiary receives it.
Speak with an investment specialist to see which one (or both) is the right choice for you.
