If you’re uncertain as to whether you’re better off contributing to a registered retirement savings plan (RRSP) or a tax-free savings account (TFSA), you’re not alone. A recent poll shows that 32% of Canadians are woefully ill-informed when it comes to the differences between the two. If you’re one of them, be sure to read on!
Both options have tax benefits. One of the main differences between the two is that RRSP contributions are tax-deductible, provided you have sufficient RRSP contribution room, while TFSA contributions are not. On the other hand, withdrawals from an RRSP are taxable – which is not the case for a TFSA.
Choosing between the two depends largely on the investment goals you have in mind. According to a recent survey, 25% of Canadians use their TFSAs for everyday savings, while 10% are putting away money to buy a home and 35% see it as an emergency fund. But 38% are using them as a means of saving for retirement, which up until 10 years ago was the exclusive realm of RRSPs.
PLANNING FOR RETIREMENT
One way to determine which instrument should be your retirement savings vehicle of choice is to analyze your current tax bracket compared with your anticipated tax bracket upon retirement. If you are in a higher bracket now than you plan to be after you stop working, contributions to an RRSP may make more sense in order to reduce your overall tax liability.
One potential pitfall of using TFSAs for your retirement strategy is that you may be tempted to use the funds for shorter-term projects instead of leaving the money alone to grow. The tax hit that comes with withdrawing funds from an RRSP is a natural deterrent for dipping into your savings.
If it’s the other way around, a contribution to a TFSA could be more advantageous. For example, a popular strategy among younger people who are still years away from reaching their peak income is to start saving in a TFSA and then move the money over to an RRSP later on to get the corresponding tax break.
Note that you cannot contribute to an RRSP past the year you turn 71, when you are required to convert it into an RRIF or an annuity. There are no such age limits applicable to TFSAs. However, you must be 18 years of age to be able to contribute.
IN THE FINAL ANALYSIS
Both TFSAs and RRSPs have pros and cons. Whether you will ultimately save more with one or the other depends largely on your tax situation and when you plan to make withdrawals. If there’s a choice to be made, talk to your trusted SLF advisor to determine which strategy is the best fit with your short- and long-term investment goals.
PATRICK VANIER CPA, CA – Partner