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This one question that always comes forward when saving for the future is whether an individual should contribute to the Registered Retirement Savings Plan (RRSP) or Tax Free Savings Account (TFSA) account and what is the difference in both investments. The fact is, both plans have some tax advantages and growth opportunities. Below provides an overview to help you decide and make the most out of your savings.
First, you need to define the reason for savings, your time horizons, your current and future tax liabilities. Whether you start with an RRSP or TFSA depends on factors like your reason for saving, your time horizon, and your current and future tax rates. Below we offer an in-depth RRSP and TFSA comparison to help you make the right call.
In general terms, RRSP’s are better suited for you if you would like to save for your retirement, your first home, or for your education. Whereas the TFSA provides advantages for your short-term goals such as a vacation, home renovations, or any major expense foreseen in the near future.
RRSP and TFSA accounts have different tax implications. An RRSP account offers a tax deduction when you contribute, and with a subsequent tax implication once you withdraw money from the RRSP account. This concept is also called tax deferral. On the other hand, the TFSA has no tax implications of contributing or withdrawing money from this account.
Growth on both accounts are tax-sheltered, which is helpful to build your saving goals quicker than keeping your money in simple savings or checking account. There are set contribution limits on both accounts and CRA allows carrying forward unused contribution room, with implications if you over-contribute.
Here are some FAQs to consider when choosing an RRSP vs TFSA.
The question also arises sometimes, if it is a good idea to invest in both accounts. If you can maximize your contribution to both accounts to enjoy tax-free growth, it is advisable to contribute to both accounts. If it is not realistic to invest in both accounts, the following information may be helpful to determine which account to start with.
You can compare your current marginal tax rate and the rate you expect to pay in retirement. This may involve a little thinking and calculation, but it could help you save a lot of money by making an informed decision for your investments.
A few factors to consider for retirement lifestyle:
• Do you want to travel?
• Do you want to learn new skills or indulge in hobbies?
• Are you expecting to maintain or lessen your current standard of living?
• How many liabilities you are expecting to have at the start of your retirement?
• What is the estimated retirement income and expenses (including regular living expenses) for the year?
Once you determine how much retirement income you need or going to have, check your tax payable. Ensure to include both federal and provincial taxes (provincial taxes may be different for each province).
If your retirement tax rate is lower, you will be better off to start the RRSP account. If your retirement tax rate is higher, you will be better off to start the TFSA account. If your retirement tax rates are the same as now, you may want to diversify your investments by contributing to both accounts. There are various online tools available to calculate your projected retirement income and how much you need to save.
The information contained was obtained from sources believed to be reliable; however, we cannot guarantee that it is accurate or complete and it should not be considered personal taxation advice. We recommend that clients seek independent advice to suit individual considerations.
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