Contributing to both a RRSP and a TFSA is a great way to capitalise on tax advantages to grow your savings. But if you can’t afford to invest in both, which one betters favours your personal financial and tax situation?
How TFSA compares to RRSP
A Tax-Free Savings Account (TFSA) shares some similarities with a Registered Retirement Savings Plan (RRSP). For instance, allowable contributions can change depending on various factors. TFSA contributions change each year ($5,500 for 2017). RRSP contributions, on the other hand, amount to 18% of the previous year’s earned income, minus any pension adjustment up to the indicated limit for the year.
You can easily find out your available contribution room for both your TFSA and RRSP using your account on the MyCRA mobile app Tax information Phone Service (TIPS).
These also have a few key differences that may affect your short or long-term savings goals, including:
A TFSA can be used for any type of savings goal, while an RRSP is specifically designed for retirement savings.
TFSA contributions are open to everyone, whereas only people with an earned income can make RRSP contributions.
TFSA contributions are not tax deductible, meaning that you can’t deduct them on your tax returns. RRSP contributions, on the other hand, should be deducted from the annual income reported on your tax return.
TFSA savings and withdrawals are tax-free because the payments are made from your net earnings. Conversely, RRSP payments are made with pre-taxed earnings, so you will pay tax on withdrawals – but not on the savings.
You can continue making TFSA contributions indefinitely.In contrast, any unused RRSP contribution room is carried forward to the next year until you turn 71. Since you won’t be allowed to make any more contributions, you will required to buy either an annuity or RRIF with your savings.
Although both options allow you to withdraw your savings at any time, the amount of TFSA withdrawals is added to the following calendar year’s contribution room. The same doesn’t apply to RRSP since contributions are based on your annual earnings (for the previous year).
Financial professionals recommend TFSA for individuals that match the lower tax bracket, such as young people who are just starting out; people with little or no savings/pension, yet they’re close to retirement age; senior citizens who are not eligible to make payments to RRSP due to age or zero contribution room; or for those looking to save for a vehicle, down payment, appliances, or other items. RRSP, on the other hand, may be ideal for individuals saving for emergencies, or those who determine that RRSP withdrawals’ marginal tax rate is to be less compared to the marginal tax rate making the contributions.
If you are facing financial debt difficulties and haven’t started saving yet, you should consider speaking with a licensed insolvency trustee for assistance with getting your finances in order.