What Savings Vehicle is Best for You? TFSA vs. RRSP

205By: Kathleen Batstone, Credit Counselling of Regional Niagara

Ever since the Government of Canada introduced Tax-Free Savings Accounts in 2009, people have been asking the question – “Where should I put my money – in an RRSP or a TFSA?”  Both of these savings plans allow participants to use a variety of investments and are a good way to save for things like retirement or education. Choosing which option is better for you depends on a number of factors.

Registered Retirement Savings Plans (RRSPs):

  • You don’t pay income tax on money you contribute to an RRSP, as long as you don’t put in more than your limit.  If you take money out of your RRSP, then you usually have to pay income tax on it.
  • The contribution limit is 18% of your previous year’s income, to a maximum of $24,270 in 2014, less any money you contribute to a pension plan.
  • You can’t make contributions to RRSPs after the year in which you turn 71.

Tax-Free Savings Accounts (TFSAs):

  • Unlike an RRSP, you pay tax on income you put into a TFSA, but interest you earn on money in a TFSA is not taxable.  That means when you take money out of a TFSA you pay no tax on it.
  • As of January 1, 2013, Canadian residents, age 18 and older can contribute up to $5,500 annually to a TFSA. This is an increase from the annual contribution limit of $5,000 for 2009 through 2012.
  • There are no age limits on TFSA contributions.

If you want to save money for a more short-term expense, a TFSA is usually the better option because you can take money out of a TFSA any time you like without paying tax. You can also put the full amount of the withdrawal back into the TFSA in future years. Make sure you understand the rules about when you’re allowed to put the money back in or you may have to pay a penalty for over-contribution.

For long-term retirement savings, one of the factors when deciding which plan is best for you is the income you think you’ll have when you retire.  Many financial planners use the following guideline: if your income is greater now than you expect it to be during retirement, go with the RRSP. One reason for this is because the tax deduction you’ll get for RRSP contributions at the higher tax rate you’re paying now will be larger than what you’ll have to pay when you take money out at your lower retirement tax rate. Most financial professionals suggest that you should take the tax refund you get from an RRSP contribution and immediately add that to your RRSP as the best way to maximize the plan’s advantages.

The second part of the guideline says: if your income is lower now than it will be when you retire, put your money into a TFSA. Unlike withdrawals from an RRSP, withdrawals from a TFSA do not count as income, so they aren’t counted when the government is determining whether you qualify for benefits like Old Age Security and the Guaranteed Income Supplement.

Of course there are other factors to consider as well when making your decision. For example, you may be able to use RRSP contributions to help buy your home or finance your education. Both the Home Buyers’ Plan and the Lifelong Learning Plan have rules about who is eligible and when you have to pay the money back, so make sure you get all the details about how those plans work.

 

Sourced from: http://www.creditcounsellingcanada.ca/CCC-Newsroom/News-Archives/articleType/ArticleView/articleId/115/categoryId/4/TFSA-vs-RRSP.aspx

Posted in Financial Matters.