Tax advantage savings are an ideal way to invest for the future. Whether it’s a long-term or short-term goal you want to achieve, it can be a struggle for many to maximize contributions to savings accounts.
If you’re considering using an RRSP or TFSA account, you might not be fully clear on the difference between the two. The following is a brief comparison to help you understand which one is right for your needs.
What is a RRSP?
The Registered Retirement Saving Plan (RRSP) has been around for many years. This plan is most often used for longer-term goals such as retirement. RRSP can shelter you from paying taxes on any contributions. However, it will be eligible for taxation if the money is withdrawn prematurely.
The amount invested can be discounted from your income, making it an ideal option if your income falls within a higher tax bracket. The reason for this is that once the investment matures and a withdrawal is made, you’re more likely to be in a lower tax bracket resulting in a smaller tax burden.
The annual contribution limits for both accounts RRSP and TFSA will vary. The RRSP allows contributions of $24,270 or 18% of your income (whichever is less).
Contributing to a RRSP can affect your eligibility for government benefits, as it can count towards your income when withdrawn. This includes benefits such as Canada Child Tax Benefit, Old Age Security, and the Guaranteed Income Supplement. It’s therefore a good idea to check with a financial expert first before you invest.
What is a TFSA?
Tax Free Saving Accounts (TFSA) is a relatively new tax-free investment account. Unlike the RRSP, there is no tax deduction for contributions made but you also do not have to pay tax on the interest you earn. The advantage of investing in a TFSA is that there is no tax payable when you make a withdrawal making it ideal for short-term goals. However you must make sure you know the contributions rules as they can be tricky for some.
With a TFSA, the contribution room can be carried forward like the RRSP. However, unlike the RRSP, the TFSA allows restoration of the contribution room a year after withdrawal, making it easy to reinvest the following year.
The TFSA allows a contribution of $5000 per year (indexed to inflation), significantly lower than an RRSP, but doesn’t affect your government benefits. This can often be the primary factor for many individuals in choosing which account they should invest in.
Both accounts allow spousal contributions and carry penalties if you exceed the contribution limit. Therefore, it’s better to stay within the limits and use the extra money towards other investment opportunities.
Understanding the difference between RRSP and TFSA accounts will help you choose the option that’s right for you. Each has its own benefits and limitations. Knowing how to maximize each for your financial goals will help you succeed financially over time.
Sources:
2. https://www.cibc.com/ca/advice-centre/savings-plan/tfsa-or-rrsp.html