We’re glad you asked.
When it comes to saving for the future, should you use a Registered Retirement Savings Plan (RRSP) or Tax-Free Savings Account (TFSA)? The answer depends on your financial goals, investment time horizon and tax situation, but it helps to know a bit about each type of account.
The tax advantages of RRSPs vs. TFSAs
RRSPs and TFSAs both have tax advantages, making them a great way to save. But the tax advantages are very different for each type of account.
With RRSPs, you make contributions in pre-tax dollars. You can claim your contributions on your tax return, which will reduce the tax you owe for the year in which you made those contributions. There’s another advantage: Any income you make on your investment will grow tax-deferred until you withdraw money from your RRSP.
However, when you do withdraw money, you’ll pay taxes on your original investment and on all of your investment income. By the time you take money out of your RRSP though, there’s a good chance you’ll be in a lower tax bracket than when you were making contributions.
With TFSAs, you make contributions in after-tax dollars. That means no tax deduction on your current income tax return. But it also means you won’t pay any taxes on money you withdraw from your TFSA -- not on your original investment or on your investment income.
For 2016, you can contribute up to $5,500 to your TFSA.
Which should you choose?
The short answer is you should choose the account that best meets your investment and planning goals.
RRSPs are generally used for saving for retirement, since there can be significant withholding taxes levied on early withdrawals. For information about withdrawal exceptions like the Home Buyers’ Plan and Lifelong Learning Plan, and withdrawing money from your RRSP in general, click here.
TFSAs are usually your best choice when saving for a short-term goal, like a vacation or a new car. TFSA withdrawals are tax free because contributions were made with after-tax dollars and there are no penalties.
When saving for retirement, choosing between an RRSP and a TFSA isn’t an all or nothing proposition. Both have unique tax advantages and contribution limits so you can invest in both and put as much money to work as possible. Also, both can hold a range of investments to help you grow your savings faster, like mutual funds, stocks, bonds, money market securities and cash.
Contact us today to help you figure out how to use both plans -- and make them work together -- based on your goals, investment time horizon and tax situation.