Whether you are saving for your dream car, a new home, or retirement, it can be quite confusing with so many investment options and advantages available. Here, we’ll focus on the Tax-Free Savings Account (TFSA) and the registered Retirement Savings Plan (RRSP), so you can decide which works best for you and your needs.
What is the TFSA?
The TFSA provides Canadians with the opportunity to have tax-free investment income. Canadians aged 18 and over can contribute, with a yearly maximum of $5500 (as on January 2013). TFSA contributions are not tax-deductible. However, you won’t have to pay tax on the contributions and any earnings you gain from the investment.
What is the RRSP?
An RRSP also allows you to save on a tax-sheltered basis up until you are aged 71. Similar to the TFSA, it can contain a variety of investments such as savings deposits, guaranteed investment certificates (GIC’s), mutual funds, and more. However, with the RRSP, contributions are tax-deductible, which is an advantage that the TFSA does not have.
So which do I choose?
First, ask yourself these questions:
Am I saving for the long-term or short-term?
An RRSP is generally more suitable for retirement due to the higher contribution limit. You can only put $5,500/year into a TFSA, but the RRSP limit is 18 per cent of the previous year’s earned income to a maximum of $23,820. Unused contribution room can be carried forward for both the TFSA and RRSP, but RRSP withdrawals are likely to be made when you are no longer working and therefore likely to be taxed at a lower rate.
The TFSA can accommodate short-term goals more easily, since any amount can be withdrawn, tax-free, at any time. In addition, you can re-contribute the full amount of your withdrawal later on. It is also the best choice for an emergency fund. If something unexpected happens, such as a job loss, you’ll want to be able to get at your money quickly, without having to worry about taxes.
Do I want to maintain my eligibility for income-tested federal government benefits?
Because TFSA withdrawals do not count as income, they don’t affect your eligibility for income-tested federal government benefits such as the Canada Child Tax Benefit, GST credit, Employment Insurance benefits and others. RRSP withdrawals count as income, so, in this case, the TFSA may be the better option.
Although there are other factors to consider, note that the main difference between the TFSA and RRSP is the timing of the taxes. You may want to visit your financial advisor to get the most benefit from your investments. Perhaps consider whether you can invest in both to maximize your tax savings.
Good luck and happy saving!