Both an RRSP and TFSA accounts provide tax shelter for your savings. But contributions and withdrawals from RRSP and TFSA accounts are treated very differently tax-wise. This is why you should consider a few basics factors before deciding which account type is right for you.
Let’s start by giving you a high five because whether you put your money in an RRSP or TFSA, your future is already looking brighter.
In case you need it, here’s a refresher on the basic differences between an RRSP and TFSA.
RRSPs (Registered Retirement Savings Plan):
Tax-deductible: Your contributions reduce the personal income tax you pay.
Tax-sheltered: Investment income and capital gains in RRSP are not taxed.
Tax-deferred: The money inside an RRSP account is not taxed until you withdraw it.
TFSA (Tax-Free-Savings Account)
Non-tax deductible: Your contributions do not reduce your personal income tax.
Tax-sheltered: Investment income and capital gains inside a TFSA is not taxed.
Tax-free: The money you take from a TFSA are not taxable.
Generally, there are three factors you should consider when deciding between an RRSP and TFSA.
Q1. What’s your goal?
If you’re saving for a short-term goal, the flexibility of a TFSA may be better because withdrawals are not taxed (you already paid taxes on the money you put into your TFSA.).
But, if you’re saving to buy your first home, consider saving your money in an RRSP to benefit from the First-Time-Home-Buyer Plan (HBP). Once your RRSP account reaches $25,000 (the limit you can withdraw under the HBP tax-free), redirect savings to a TFSA. This way, you can withdraw $25,000 from your RRSP and additional savings from TFSA―also tax-free―for your new home.
Don’t forget, the money you withdraw under HBP needs to be returned to your RRSP account over a maximum of 15 years, starting in the second year after buying your home.
If your goal is long-term, say saving for retirement, an RRSP is still a good option.
Q2. Are you in a high or low tax bracket?
RRSP contributions lower the income you pay tax on. When your income goes up, so does your personal tax rate. So, if you’re in a higher tax bracket, consider putting your money into an RRSP to reduce taxes.
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If you’re in a low tax bracket but think you will be earning more in the future, consider parking your money in a TFSA. In the meantime, carry-forward your RRSP contribution room into the future when you get into a higher tax bracket. Then use your TFSA savings to make a sizeable RRSP contribution to reduce the tax you pay. As a result of increasing your RRSP contribution amount, can also boost your income tax refund, which you can use you to pay off debt.
Remember, unused RRSP contribution room from each year can be carried forward and leveraged at a more advantageous time (i.e., when you’re earning more).
Q3. Will you get a big pension?
TFSA withdrawals are not considered income and are not taxed as a result.
In retirement, if you have a high income, you may lose or become ineligible for some federal income-tested benefits such as Old Age Security benefit (OAS). To provide perspective, the OAS clawback threshold for 2017 is $74,788. This means any income above this threshold reduces the benefit you can get.
So, if you expect significant pension income, put some savings into a TFSA. That way you don’t risk losing certain government benefits and you keep your taxable income low.
These are just a few tips to help you decide. Naturally, your decision will depend on your personal and financial circumstances.
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