Do you know the main differences between an RRSP (Registered Retirement Savings Plan) and a TFSA (Tax-Free Savings Account)? Both types of accounts can help you plan for your financial future while providing tax benefits, but each offers different advantages and limits. Consider your savings goals, income sources, and lifestyle when deciding between the two to help you make the most logical choice that maximizes your future savings.
Both RRSPs and TFSAs both provide tax benefits, but when you’re taxed differently between each plan. Contributions to RRSPs are tax-deductible, while contributions to TFSAs are not. The tax-deductible nature of RRSPs also means that there is a yearly deadline for contributing income to your RRSP, while TFSAs have no deadline. Conversely, withdrawals from TFSAs are tax-free, but RRSP withdrawals are taxed.
Consider where tax benefits will assist you in your saving the most. Will having tax-deductible savings contributions significantly decrease your tax liability, given your income tax bracket? If so, an RRSP may be the right choice for you. If you’ll benefit more from enjoying tax-free withdrawals (for example, if you’re saving for major non-retirement related expenses), then a TFSA may make more sense for you.
The annual contribution limit for RRSPs is much higher than it is for TFSAs. In 2016, the contribution limit for RRSPs was either 18% of your annual earned income, or $25,370 (whichever is the lower number), while TFSAs in 2016-2017 had a contribution limit of $5,500.
Both RRSPs and TFSAs allow you to roll-over any unused contribution room from previous years. However, making a withdrawal from your RRSP will result in a permanent loss of contribution room. If you need to withdraw from your RRSP at any point, that amount does not roll over to future years and cannot be “made up” for. On the other hand, any withdrawals made from your TFSA can be added to your contribution room in future years.
When it comes to income sources, TFSAs are more flexible than RRSPs. The contributions you can make to your RRSP are also confined to earned income only, while TFSAs can hold other types of income in addition to earned income, such as gifts, mutual funds, stocks, and bonds.
Both TFSAs and RRSPs have a minimum age requirement of 18. However, because RRSP contributions are confined to earned income, some young people may not be able to open one if their contributions will come from sources other than earned income. Additionally, TFSAs have no maximum age limit for closing the account, whereas RRSPs must be closed by the time the account holder is 71 years of age, at which point the funds must be transferred to an annuity or RRIF (Registered Retirement Income Fund). If you anticipate receiving any form of significant income after the age of 71, holding it in a TFSA may be a wise choice for you.
Choosing the best way to save your money involves a number of variables that can be difficult to predict. It’s always best to check with an independent wealth manager or financial advisor to help you choose the option that makes the most sense for your financial situation. Contact us at Rae Lipskie to book an appointment for planning your financial future.