Registered Retirement Savings Plans (RRSPs) and Tax-Free Savings Accounts (TFSAs) are both registered investment vehicles that offer incentives for Canadians to save. They are not investments themselves, but instead serve as a container where you can hold your investment products, such as Guaranteed Investment Certificates (GICs) or mutual funds.
Here are the differences between the two and some tips to help you choose which one is best for you and your financial goals.
RRSPs and TFSAs are taxed differently
The biggest difference between an RRSP and TFSA is when you pay tax.
When you use an RRSP, your contributions are considered “before tax” money because those investments are tax deductible. Your investment earnings are tax-deferred, meaning you’ll have to pay tax on the money when you withdraw it from the account, when you’re ideally in a lower tax bracket.
In comparison, with a TFSA, your contributions are made with "after tax" money. Although the contribution is not tax deductible, you are making it with money you have already paid tax on—the benefit of a TFSA is that your investment earnings and withdrawals are tax-free going forward. Your growth is never taxed.
Should you use a TFSA or RRSP?
If the amount of tax you’ll need to pay is your only concern, follow these general guidelines:
- If your income tax rate is likely to be higher when you make withdrawals, use a TFSA.
- If your income tax rate is likely to be lower when you make withdrawals (i.e. when you retire), then choose an RRSP.
You should also consider flexibility and access to funds
Although you should definitely consider taxes when making your decision, you should consider other factors too—like your saving and spending habits.
Because you don’t have to pay tax when you withdraw from your TFSA, it’s easier to access those funds at any time, for any reason. As such, TFSAs are a great option if you are unsure when you will need to use your savings. Just know that you can’t re-contribute back into your TFSA in the same calendar year, unless you have unused contribution room.
But if you are committed to saving for retirement and want to avoid the temptation of accessing those savings earlier, an RRSP is the wise choice. The tax consequences of withdrawing RRSP funds can be significant, so it’s always best to leave those savings untouched until you’ve retired. For this reason, the inflexibility of an RRSP might be better for you even if the numbers point to a TFSA.
The types of accounts in which you hold your investments can be just as important as the investments themselves. If you’re interested in learning more about investing and what options are best for you and your financial goals, call our Wealth Advice Centre at 1-855-541-4387. Our advisors are here to help guide you through your investing journey and find a solution that suits your needs.
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