TFSA vs. RRSP – Which Is Right for You?

The amounts that you contribute are NOT a deduction for you on your tax returns. This means that any income that is earned in the account is truly tax-free. You won’t pay any tax on the amounts when you withdraw the funds ten, twenty or fifty years later.

RRSPs

Unlike a tax-free savings account, a RRSP is designed to defer tax. This means that you get to deduct your contribution today, and pay the tax later when you withdraw the funds! Any increase in value to your RRSP will only be taxable when you withdraw those funds, deferring the tax you’ll owe.

But wait! Not everybody is able to contribute to a RRSP. Luckily, CRA will provide this number for you on your notice of assessment each year. One less thing to worry about or calculate!

Consider Your Income

If you have high taxable income, RRSPs are a great tool. Let’s say you are making $120,000 a year. If you contribute $10,000 to an RRSP, your taxes will be reduced by 36% or $3,600. But what if you only made $40,000 a year and made that same $10,000 RRSP contribution? Now, that RRSP contribution is only going to be saving you about 25% tax (or $2,500).

If during retirement, you are going to be having about $40,000 in taxable income from your RRSP and other government pensions, you are going to be in that 25% tax bracket; if you were in that higher tax bracket when you were contributing, you have saved 11% by contributing to a RRSP. If you were originally in a $40,000 tax bracket when you made the contribution, you aren’t saving any tax – but you were able to shift that tax to later in life – which still might be beneficial for you!

Ideally, you want to contribute to RRSPs when your income is high and then draw down on it during retirement, when your income is lower.

How Did You Want to Use the Funds?

If you want to save some funds for a rainy day or a future renovation project or vacation, TFSAs might be right for you. It allows you to stash away some extra funds, have those funds build through interest or appreciation, and then remove them tax-free. And even better, you will regain that original contribution room the following year to start saving again!

With an RRSP, withdrawing funds will result in taxable income. Your bank withholds tax – at a rate of 10, 20 or 30% (depending on how much you withdraw). So if you withdraw $15,000, you will only receive $12,000. You also won’t regain that contribution room.

What Did You Want to Invest In?

If you love US stocks, your RRSP is the place to hold them. The US recognizes RRSPs as a retirement account and thus, you won’t have any non-resident withholding tax associated with these stocks. Unfortunately, with a TFSA, foreign tax will be withheld and since the income is tax-free to you, you won’t be able to utilize that tax as a credit on your tax return and will instead lose it.

If you can afford to max out your contributions on both options each year, do it! You’ll get a tax deduction today and you’ll have tax-free money for the future.

Before making your contributions, don’t be afraid to reach out to your tax advisor! They can help ensure that you are making the best choice for your situation.

by Jillian Koch - JMH & Co

TFSA vs. RRSP – Which Is Right for You?

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