Whether to invest in a registered retirement savings plan (RRSP) or a tax-free savings account is one of the most popular questions today. Both TFSAs and RRSPs provide tax benefits that will help you meet your goals of saving and investing. Both the TFSA and the RRSP are investment programs that shield your investment gains from taxation, but one may be better for your money than the other, depending on your income. So, what is the best thing for you?
The TFSA, first introduced in 2009 to Canadians, has proven to be very common. Each year, you get an allotment of $6,000 available for your TFSA, which means that you can put that amount away, plus any rollover from previous years (assuming you were 18 or older in 2009, you have a lifetime limit of $69,500 as of 2020). This money has already been taxed. You contribute to a TFSA from your net income, but there is no tax exemption at the time of contribution.
Without paying income tax on that money, a registered retirement savings plan, or RRSP, allows you to spend up to 18 per cent of your gross income each year, or $26,500, whichever is less. (If you invest in after-tax dollars, after you file your income tax return for the contribution year, the tax will be refunded.)
In this way, an RRSP allows you to defer your taxes while saving for retirement. The most significant thing to understand is that if you withdraw it, you will pay tax on this money. The concept is that you will be in a lower tax bracket because you will be retired than during your high-earning years, and so you will pay less tax overall because you invested in an RRSP.
Which is better? The short answer:
When you make more than $50,000 then RRSPs is better.
When you make below $50,000 then TFSAs is better.
The tax bracket is directly related to your income, the amount of income tax you have to pay and all these factors will influence which investments work best for you. If you earn more than $50,000 annually then you can invest in an RRSP. The reason is that the money you put in is tax-deductible and your deductions go towards reducing what you owe.
For those who earn less than $50,000 a year, the deduction is less important, since after receiving simple tax credits, you aren’t expected to owe any income tax. In these cases, putting your money into a TFSA may make more sense.
Which is better? The short answer:
For longer-term investment goals, such as retirement, RRSPs is better.
TFSA is better when you think of an emergency fund or purchasing a vehicle, in a shot for short or medium-term investment targets.
It’s a good idea to identify what you’re saving for if you invest. Putting away money for retirement is usually on a longer timeline than, say, your child’s education fund or a home renovation. For your retirement, your RRSP money is earmarked. The program is designed so that when you withdraw the money you will be earning less, and therefore in a lower tax bracket and so will pay less overall tax in your lifetime. This is better for its intended purpose but remember that it will not help you with short- or medium-term goals. So you will be beneficial with TFSA, given that you can make withdrawals tax-free and with no penalties. When you invest money in TFSA then you can easily withdraw it buy a car with no tax implications.
So which plan to choose?
RRSP is the better choice here and the reason is the availability of the Home Buyers’ Plan and Lifelong Learning Plan.
Remember how to design your RRSP for your retirement? In the form of the Home Buyers’ Plan and the Lifetime Learning Plan, there are indeed a few significant restrictions to that. For the eligible homebuyers, HBP allows withdrawing up to $35,000 from their RRSP to put towards their purchase. You do not have to pay any tax on it but you should repay it within 15 days. This is a perfect way to obtain a big lump sum, such as for a down payment, and the “loan” is interest-free, although it must be repaid.
Likewise, the Lifelong Learning Plan (LLP) is a program that allows you to use your RRSP savings, up to $20,000 for 2 years, for your own (or your spouse’s) full-time education or training. It is important to repay the sum within 10 years.
So which one to choose?
RRSP looks good but remember that it depends upon your income as we have stated in point 1.
For a working individual or retired one, withdrawals from TFSAs are always tax-free. The same does not happen with RRSP as withdrawals from it are always taxable. You are expected to be in a lower tax bracket when you are in retirement which means that withdrawals from the RRSP would be taxed at a lower rate than when you earned the money you initially contributed. Note: If you find that you have a tax refund, you can maximize it by reinvesting the balance into a TFSA.
When saving and preparing for retirement, it helps to take a considered and long-term approach with your decisions—and to personalize them. Retirement preparation, whether on your own or with a specialist, will help justify your decisions and help you set goals for the future.
We can say that TFSA is much more flexible as it provides better tax benefits than the Registered Retirement Savings Plan but it does not offer a high contribution room. On the other hand, RRSP will give you options but it also has stricter rules around especially when you can withdraw your money and what for. In the end, everybody should strive at getting both an RRSP and a TFSA and distribute the savings across both accounts.