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RRSP, TFSA or both?


Public service announcement: With tax season fast approaching, it’s time to start thinking about topping off your registered accounts to maximize your tax benefits. Hopefully you’ve squirreled away some savings because you have until March 1 to make your contributions. But where should you park your money – in a Registered Retirement Savings Plan (RRSP) or a Tax-Free Savings Account (TFSA)?

That was a trick question because the answer is: ideally both. They each have amazing tax benefits that can help you save big over the long term. But let’s say you only have enough to contribute to one of them this year. Which should you choose and why? To answer that question, you’ll need to understand both. Let’s take a look!

Registered retirement savings plans explained.

As the name suggests, RRSPs are government approved investment plans that are designed to motivate you to save for retirement. You can kind of think of them as the engine that will power you through your retirement. And that engine needs fuel in the form of consistent contributions each year.

The main benefit of RRSPs is that taxes on your contributions are deferred until you ‘cash out’, ideally in retirement. The idea is that you save on taxes during your peak earning years while you’re in a high tax bracket. Then, cash out in retirement when you’ll be in a lower tax bracket and thus pay less taxes.

But there’s more – your income is also decreased by the amount you contribute. So, if you’re thinking strategically and have enough contribution room, you can potentially reach a lower tax bracket by contributing enough to lower your income to that bracket.

That isn’t always possible because there are limits to how much you can contribute. To see your limit for this tax year, it’s best to refer to the Government of Canada website. Also, if you don’t use your contribution room, it’s carried forward. To see how much room may have accumulated, you can examine your Notice of Assessment or log in to your CRA account.

RRSPs are meant to be saved until retirement, but you can cash them out earlier. It just means you’ll need to pay income tax on them at that time. If you’re thinking about purchasing a home, the Home Buyers' Plan (HBP) also allows qualified individuals to withdraw RRSP funds (up to a limit) without incurring payable taxes if they are paid back within a 15-year period.

Tax free savings accounts explained.

TFSAs are also government approved accounts that are meant to encourage saving and investing. Like an RRSP, the account can hold any registered investment products, including stocks, bonds, mutual funds, GICs and cash.

The main benefit of a TFSA is that any interest, dividends or gains earned by money or investments within the account can be withdrawn tax-free. Without the TFSA, you would need to pay capital gains tax on those investments. In Canada, 50% of the value of capital gains are taxable as income.

For example, if you had $5,000 in mutual funds in your TFSA and it went up to $7,000, you could cash it out without paying any taxes. But if it wasn’t in your TFSA, you would need to claim 50% of your capital gains as income, so $1,000 would be added to your annual income for tax purposes.

Like RRSPs, there’s a limit to how much you can contribute each year, and any unused space will carry forward to future years. To see this year’s limit, visit the Government of Canada website. Also, any withdrawal amount is added back to your contribution room at the beginning of the following year.

Which should you choose?

Ok, let’s get back to our question from the beginning! Assuming you can’t contribute to both this year, where should you park your money – in a TFSA or an RRSP? To get the answer, you need to assess your personal needs and your goals.

  • Are you saving for the long-term? If you are saving for retirement, for example, an RRSP makes a lot of sense. It’s what it’s designed for, after all. Plus, you get the short-term benefits of reducing your taxes.
  • Do you have any big-ticket expenses coming up? If you’re going to need access to your funds sooner than later, like for a wedding, for example, a TFSA may be a better option because you can withdraw funds at any time without needing to pay any taxes.
  • Are you planning on purchasing your first home soon? In this case, either option would work well. You can withdraw your TFSA money anytime with no penalty, and you can access your RRSP money through the Home Buyers’ Plan without incurring taxes.
  • Are you planning to go back to school? If so, your RRSPs also give you the option to withdraw up to $10,00 in a calendar year to finance your education through the Lifelong Learning Plan.
  • Are you close to a lower tax bracket? If you are, RRSPs enable you to deduct your contribution from your income, potentially bringing you down to a lower tax bracket thus allowing you to pay less taxes.
  • What are you investing in? If it is an asset with the potential for high growth, you may want to invest in it through your TFSA which shields your capital gains from any taxes. If it’s a less risky investment with a more moderate return, perhaps invest through your RRSP.

Essentially, both have amazing tax benefits, but your money is more easily accessible in the short-term with a TFSA, except in the case of buying your first home or education costs. Ideally, you’ve saved up enough to contribute to both, but if you have to decide between the two, the answer is up to you. Weigh your short-term needs against your future goals, then make a plan – both are great options.

If you have any questions about how to make your contributions or what to invest in through your TFSA or RRSP accounts, your best bet is to make an appointment with a wealth advisor who can analyze at your specific circumstances an provide personalized recommendations.