RRSP or TFSA – Which is Right for Me?
If you want to begin saving for retirement, but are not maxing out the tax-sheltered savings accounts offered by the Canada Revenue Agency, you will face a trade-off between stashing your savings in a Tax Free Savings Account and a Registered Retirement Savings Plan. While each has benefits and drawbacks, there is no one-size-fits-all solution, and making the best decision for yourself will require some speculation as to your means and needs decades into the future.
How Does It Work?
The key to understanding the difference between the two programs is when you pay taxes. In the case of an RRSP, you deduct contributions from your income, reducing your income by that much in the current year. Instead, the income enters your account where it can grow tax-free until you withdraw it, at which point it increases your income. Each year, you can deduct a certain amount to put into your RRSP (currently, 18% of your income, to a maximum of $26,010). If you cannot use all of this room in any given year, it carries forward indefinitely.
In contrast, you pay into your TFSA with post-tax income, the money in your pocket after you have paid your taxes. Like the RRSP, your contributions collect tax-free interest in your account. However, when you withdraw from your TFSA, the tax bill is already covered, and you do not need to add TFSA withdrawals to your income. You are allotted a certain amount of space each year you are over the age of 18 (in 2017, $5,500).
Both accounts can hold a number of common investments, such as money, bonds, or publicly traded stocks.
Account Flexibility
RRSPs are less flexible, and are directed specifically towards saving for retirement (with two exceptions, the purchase of your first home or paying for education and training allow you to borrow from your RRSP). When you withdraw from your RRSP, not only will the CRA treat this withdrawal as income, but your financial institution will take a bite out of your withdrawal through a “withholding tax” of between 10% and 30%. This withholding is essentially pre-paying some of the taxes you will owe at the end of the year. Not only that, but you cannot get contribution room in your RRSP back. When you turn 72, you are forced to close your RRSP and cash it out or convert it to other savings vehicles.
TFSAs can be used to reach any kind of savings goal, and as such, you can withdraw from them easily and without paying any taxes. But once you withdraw money from your TFSA, you cannot get the tax savings room back until one year in the future.
RRSP or TFSA – Which is Right for Me?
In the broadest strokes, if you are currently in a lower tax bracket than you expect to be when you retire, this suggests that the TFSA may be a better bet, as you pay lower taxes now, rather than higher taxes later. In contrast, if you pay higher taxes now than you expect to during retirement, this nudges you towards the RRSP.
A 20-something entering the workforce may better served by a TFSA, while that same taxpayer at the peak of their earning potential in middle age likely finds an RRSP preferable.
But it can be more complicated, as your effective tax rate may differ for reasons other than your income. The two programs affect eligibility for income-dependant credits differently. Paying into your RRSP can increase your eligibility for some income-dependant tax credits, such as the Canada Child Benefit. Alternatively, withdrawals from your RRSP can boost your income, potentially risking claw backs from income support programs such as the Guaranteed Income Supplement. Because TFSA withdrawals are not income, they will not affect credits based on income.
Whether a TFSA or an RRSP is right for you depends on your circumstances, and this brief summary cannot substitute for professional advice.
What If I am Being Audited in my TFSA or RRSP
If you are being audited in your TFSA, or RRSP, and are wondering what to do, please read our article found here regarding this scenario and call us if you have questions.
What if I have Over Contributed to my TFSA or RRSP
If you have over contributed to your TFSA or RRSP, please see our article found here for more information, and call us if you have any questions. If you have not been contacted by the CRA, you may be eligible for a voluntary disclosure.
Tax planning may be very difficult for those who do not have specific expertise in the area. Should you have any questions regarding contributions, withdrawals, audits, or excess contributions to your TFSA, or RRSP, R&A Tax Law has the skill and experience necessary to guide you. Be sure to contact us today to learn more!
**Disclaimer
This article provides information of a general nature only. It does not provide legal advice nor can it or should it be relied upon. All tax situations are specific to their facts and will differ from the situations in this article. If you have specific legal questions you should consult a lawyer.
Jason Rosen