You are not alone; at this time of year, I get a lot of questions around whether it’s better to invest in a Registered Retirement Savings plan (RRSP) or a Tax-Free Savings Account (TFSA).
Hopefully, this will help you decide.
The RRSP is essentially a tax deferral strategy, meaning investors put off paying the tax on their income until a future date; usually during retirement when they are earning less money and are therefore in a lower tax bracket. When you invest in an RRSP you get a tax deduction which could result in a refund of tax you paid during the year. The amount you can invest is based on your income; 18% of the previous year’s income or the annual maximum ($29,210 for 2022). Unused contribution room is carried forward indefinitely and can be used in future years when you have extra cash to invest; or need to shelter a lump sum payment like a bonus or severance package. If you have not maximized your contribution, a running total can be found on your tax assessment. The money in your RRSP grows tax-sheltered until withdrawn; this means you don’t have to pay tax on investment income annually like you do with non-registered accounts.
Ultimately, the goal for your RRSP is to provide you with income once you decide to stop working, this is becoming more and more important as many companies are reducing or eliminating their pension benefits.
The TFSA is also a registered account and therefore lets investors grow their money tax sheltered; thereby paying no tax on investment income. However, investors will not receive a tax deduction or refund when they invest in a TFSA, instead all money (including investment income) can be redeemed from the account tax free regardless of when and how much is withdrawn. Furthermore, unlike the RRSP, you do not lose your contribution room if you redeem money, the only catch is you must wait until the following year to re-contribute; otherwise, it may be counted as a double contribution and result in a penalty. The TFSA was created in 2009 and the contribution amount is the same for everyone, currently its $6500/year. The total allowable contribution amount for 2023 is $88,000. If you have more than one TFSA or have taken money out in previous years, you can find out your contribution limit on-line through your Service Canada account.
Which Do You Choose?
In most cases, if you are earning over $30,000 in income, need some tax relief and do not need the money for a specific purpose, I would suggest investing into an RRSP. If you are saving for something specific like a car or vacation; the TFSA would be a better option. In addition, for those that have maxed out their RRSPs and are continuing to save; the TFSA is an excellent investment vehicle. The money can still be used for a specific purpose, emergency fund or additional retirement savings.
If you are still having trouble trying to decide, or have any questions, give me a call.
Have a weekend,
Tracey
Source: information update CRA website, Canada.ca MT 2016-02-12