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RRSP vs TFSA

Question

Should you invest in an RRSP or a TFSA?

That depends! Generally, the tax rate at the time you invest verses when you withdraw, will determine your best option. 

Most Canadians can benefit from having a Registered Retirement Savings Plan (RRSP or RSP for short) and a Tax Free Savings Account (TFSA) — both are great tax-sheltered savings vehicles.

The key difference is whether you pay taxes now or later. RSP contributions are tax deductible, so they generate a tax credit. But withdrawals are taxed as income.

TFSA contributions are made with after-tax dollars, so withdrawals are not subject to taxation. This makes TFSAs ideal for an emergency fund, as well as for saving for a vacation or other big ticket item.

The TFSA and RRSP put the same amount of money in your pocket if your tax rate stays the same over time. However, if you think your tax rate will be higher when you withdraw your money, a TFSA has the advantage. If you anticipate your tax rate will be lower, then an RRSP is a better choice. Your circumstances and goals will determine how you allocate your resources. 

TFSA vs. RRSP

$23,730 VS. $19,240

TFSA vs. RRSP

$19,240 VS. $19,240

TFSA VS. RRSP

$19,240 VS. $23,730

Balance

HIGHER TAX RATE LATER CHOOSE TFSA

TFSA: $4,490 more in your pocket

If you have a generous pension plan, or other reasons to expect to enjoy a comfortable retirement lifestyle a TFSA may make more sense. For example, if you are going to invest the money at a 26% tax rate and withdraw at 40%, you will have $4,490 more in his pocket!

TFSA contributions will provide tax-free income in retirement. By comparison, withdrawals from an RSP (and from a Registered Retirement Income Fund) are taxable and, combined with other income sources, could push your taxable income high enough to trigger a clawback of your Old Age Security pension.
Balance

SAME TAX RATE LATER CHOOSE EITHER

TFSA = RRSP


The TFSA and RRSP put the same amount of money in your pocket if your tax rate stays the same over time. If you bith invest and withdraw at a 40% tax rate, all other things considered equal, your investment would net you the same amount.
Balance

LOWER TAX RATE LATER CHOOSE RRSP

RRSP: $4,490 more money in your pocket

If you believe your tax bracket in retirement will be lower than it is currently, RRSP might be the smarter choice.

RSP contributions give you a tax break now, and your withdrawals in retirement may be taxed at a lower rate. This illustration assumes you invest while at 40% tax rate and withdraw at 26%.

Of course, it's not always that simple!

Here are some other guidelines to consider when deciding to invest in a TFSA verses an RRSP

Want easy and frequent access to your money, use a TFSA. You’ll be able to withdraw funds tax-free at any time and re-contribute the same amount in the future. Keep your RRSP for long-term retirement savings.

Earn a low income
you may benefit more from the tax-free growth and withdrawal flexibility of a TFSA than from the modest tax deduction of an RRSP.

Starting your career
, then invest in a TFSA before an RRSP. Over the years you’ll accumulate RRSP contribution room that you can eventually take advantage of when your income is higher and when claiming the RRSP tax deduction has a bigger impact.

Need to borrow money
a TFSA can be used as loan collateral. Just remember, the interest on money borrowed to invest in a TFSA is not tax deductible.

Saving for a house or education
a TFSA may be a better option than the RRSP’s Home Buyers Plan or Life Long Learning Plan. That’s because TFSA withdrawals don’t have to be paid back, money doesn’t have to be kept in the account for 90 days before withdrawing, and if you decide to use your money for another purpose, you don’t have to pay tax.

Have interest-bearing investments
, like GICs, money market mutual funds, term deposits, or bonds, which are taxed at higher rates, put them in a TFSA where they are tax sheltered.

Own high risk/high return investments
a TFSA might be better than an RRSP or non-registered account. If your $5K grows to $50K it could be withdrawn tax-free. The downside — you can’t claim a capital loss if your investments lose value.

Hold investments in a non-registered account
, consider transferring them ‘in-kind’ to your TFSA so they can grow tax-free. But talk to an expert first because there may be tax consequences.

Have a pension plan at work and therefore have limited opportunities to contribute to an RRSP, use a TFSA to augment your retirement savings.

Retiring in 10-20 years
use a TFSA to complement your RRSP and grow your nest egg more aggressively.

Making maximum RRSP
contributions, put additional savings in a TFSA before a non-registered plan so your money can grow tax-free.  

Need to reduce taxable income in retirement
, use a TFSA in addition to your RRSP. After you convert your RRSP into a RRIF at age 71, RRIF withdrawals are taxed, and more money you withdraw the higher your marginal tax rate. But by also withdrawing tax-free funds from a TFSA you can reduce your RRIF withdrawals, potentially lowering the overall tax you pay.

Don’t need all your RRIF/LIF withdrawal cash
, move it to a TFSA where it can grow tax-free until you need them later.

Receiving Old Age Security, the Canada Child Tax Benefit, EI or the GIS
invest in a TFSA to avoid potential clawbacks. TFSA interest earned or withdrawals aren’t considered income so won’t affect your benefits.

These are all only generalizations. Your situation is unique. If you want to find out how to use the Tax-Free Savings Accounts to your advantage, drop by the investment area of your branch and talk to one of our Credential Asset Management Inc. Mutual Funds Investment Specialists. They can provide you with an expert’s perspective and help you invest in the future.

Credential Financial Strategies Inc. is a member company under Aviso Wealth Inc., offering financial planning, life insurance and investments to members of credit unions and their communities. The information contained in this article was obtained from sources believed to be reliable; however, we cannot guarantee that it is accurate or complete and it should not be considered personal taxation advice. We are not tax advisors and we recommend that clients seek independent advice from a professional advisor on tax related matters.