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TFSA vs RRSP: Which to choose?

Many people wonder whether to invest in a registered retirement savings plan (RRSP) or a tax-free savings account (TFSA). The two will both save you money, as well as reduce your overall tax burden, but in very different ways. When you understand how these accounts work, you can decide which is best for you and when to use them, and when to use them together.

What is a TFSA?

Anyone over the age of 18/19 (depending on your province of residence) can use a tax free investment savings account (TFSA) to save money or hold investments. ETFs, guaranteed investment certificates (GICs), bonds, stocks and/or cash can all be saved in a TFSA.

In TFSAs, income earned is tax-free, including interest, stock dividends, and capital gains. However, contributions to TFSAs won't reduce your current taxable income like contributions to RRSPs do.

A TFSA has an annual contribution limit, but unused contribution room can be carried forward to the lifetime maximum amount, which is currently 88,000. In your TFSA, you have an allotment of around $6,000 per year, which means you can invest that amount, plus any unused contributions from previous years. You can find out what your current contribution limit is by visiting your CRA My account or looking at your current notice of assessment

TFSAs are tax-free because you contribute them with your net income, that is your income after paying taxes - so there is no tax break at the time of contribution. But when you withdraw your money from a TFSA, you won't be liable for any type of taxes including capital gains tax, so you'll never owe tax on your earnings or money you take out of your TFSA.

What is an RRSP?

In the same way as a TFSA, registered retirement savings plans allow you to save and invest, but the RRSP generally allows you to contribute larger amounts of money every year, reducing your taxable income accordingly. It allows you to defer your current taxes while saving for retirement. The maximum RRSP contribution limits are $30,780 in 2023, $29,210 in 2022, $27,830 in 2021, and $27,230 in 2020. Your contribution limit is calculated every year after filing your taxes and is 18% of your earned income for the year (please be aware that not all types of income count towards earned income). You can find your current limit in your CRA My account or on your most recent notice of assessment.

The money that you withdraw from your RRSP will be subject to tax in the year you make the withdrawal.. When you turn 71, you can no longer contribute to your RRSP and must either withdraw the full balance and pay applicable taxes or transfer the balance of your RRSP to a registered retirement income fund (RRIF). The concept behind investing in an RRSP, is that you will be in a lower tax bracket when you withdraw at retirement than you were when you earned the high income in your 30’s, 40’s, 50’s , so you will pay less taxes overall.

Based on your individual financial situation and goals, the best investment option for you is something you need to look at individually and overall. TFSAs require you to pay tax on your income earned before you make contributions, while RRSPs require you to pay taxes later on in life, when you withdraw your money. In addition to your income, your investment timeline, and other things such as your spending habits, these factors will help you decide on the right investment for you at a given point in time.

It is also possible to use both vehicles simultaneously, so which is better, TFSA or RRSP?

1) Looking at your Income and Tax Bracket: The money you put into an RRSP is tax deductible, so your deductions go towards reducing your current tax liability. If you make less than $50,000 per year, the deduction is less valuable, since you aren't likely to owe much income tax after you claim basic tax credits. In such cases, you are probably better off putting your money in a TFSA.

2) Looking at your Time Horizon: When you withdraw your RRSP money, the theory is that you will be earning less money, which will put you in a lower tax bracket. The RRSP program is designed to help you pay less in taxes overall. While this is effective for its intended long term purpose, it doesn't help you achieve short- and medium-term savings goals. A TFSA might be the better option for those short to medium term goals, since withdrawals are tax-free and penalty-free.

3) Looking at Group Plans: RRSPs or similar tax-deferred accounts, like defined contribution pension plans, can be made even more valuable if your employer matches your contribution. Usually, employer contributions work like this: your company matches your contributions — sometimes dollar for dollar, sometimes more, sometimes less, giving you free money to invest. If you have access to a matching program, I highly recommend taking advantage of it for the free $.

4) Looking at Saving for your Education or your First Home: Eligible homebuyers can withdraw up to $35,000 from their RRSPs to put towards their purchase through the Home Buyers Plan (HBP). It's a great way to access a large lump sum, such as for a down payment, and while it must be repaid over the next 15 years, the loan is interest-free. Similarly, the Lifelong Learning Plan (LLP) allows you to use your RRSP savings to pay for full-time education or training up to a $20,000 withdrawal over two years, and you would repay that within 10 years of finishing school.

5) Last looking at Retirement: In TFSAs, withdrawals are always tax-free, whereas RRSP withdrawals are always taxable. Retirement should mean RRSP withdrawals are taxed lower than when you earned the money that you contributed, so you pay less in taxes overall. Tip: If you get a tax refund, I recommend that you reinvest it into your TFSA.

Take these five factors into account before choosing where to deposit your money - a (RRSP) or (TFSA)

Until next time,

Christine Walters

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