Should I contribute to my RRSP or my TFSA?

With the availability of Tax-Free Savings Accounts (TFSA), does it still make sense to contribute to a Registered Retirement Savings Plan (RRSP)?  Determining which plan or what combination of plans is best for you will depend on your personal situation and your objectives.

The major difference between a TFSA and an RRSP is the treatment of contributions and withdrawals for tax purposes.  RRSP contributions are tax-deductible, but withdrawals are taxed as earned income.  On the other hand, TFSA contributions are not tax deductible, but withdrawals and the earnings and growth on investments are completely tax free.

Furthermore, TFSA withdrawals have no effect on an individual’s eligibility for federal income tested benefits and credits, unlike RRSP withdrawals, which are included as income for the purposes of calculating benefits.  This may be particularly important to seniors who receive Old Age Security and the Guaranteed Income Supplement.

Generally, an RRSP is used for saving for retirement, while a TFSA can be used for both saving for retirement and other shorter-term needs.  Because TFSA withdrawals are added back to your available TFSA contribution room in the following calendar year there is very little downside to using TFSA savings for mid-sized to large purchases.  Anyone saving outside an RRSP should consider contribution to a TFSA first.

The TFSA and RRSP are both important tax-advantaged savings plans sponsored by the Government of Canada.  Generally, one is not better than the other; they work together to give Canadians valuable tax benefits.  A TFSA can be an excellent complement to an RRSP and may be used to maximize retirement income when RRSP contribution limits have been reached.

The Retirement Income Decision:

·        Choose an RRSP when pre-retirement income is expected to be higher than retirement income.  Income during retirement may benefit from a lower income tax rate.

·        Choose either a TFSA or an RRSP when pre-retirement income is anticipated to be equal to retirement income.  Income tax rates may be equal before and during retirement, so there is no advantage to one over the other.

·        Choose a TFSA when pre-retirement income is expected to be lower than retirement income.  Income during retirement may be withdrawn tax free from a TFSA.

                                                                    
As your Financial Planner I can help you determine which tax-advantage strategy best suites your needs.  Furthermore, I can help you figure out the amount you need to save to achieve your goals, and the most appropriate investments keeping in line with your risk tolerance.  If you are still having trouble making the choice between your RRSP and your TFSA; give me a call.

Have a great weekend,

Tracey

 

Source:  Fidelity Investments, and Manulife Solutions, Winter edition 2012/13,