Should I contribute to my RRSP or TFSA? It’s a common dilemma faced by countless Canadians. In a perfect world we’d contribute the maximum to both. Unfortunately, the world is far from perfect. Things like a mortgage and children (as lovely as they are, I have two myself) tend to be a drag on cash flow. But fear not, we have the answers! Let’s take a look at both account types and see when choosing your TFSA over your RRSP makes sense.
An RRSP (Registered Retirement Savings Plan) is a tax-sheltered account mainly used for saving towards retirement. Anyone with earned income can contribute toward an RRSP. You can contribute the lesser of 18 percent of your earned income in the last year, or the RRSP limit for the current tax year ($25,370 in 2016).
When you contribute to your RRSP, you receive a tax refund from the government. RRSPs can hold a variety of investments, including savings accounts, GICs and mutual funds. If you’re fortunate enough to have a pension plan at work, your RRSP contribution limit will be reduced by a pension adjustment (box 52) on your T4 tax slip. This creates a level playing field between those with pensions and those without.
Tax-Free Savings Accounts (TFSAs) are the new kid on the block. Introduced in 2009, TFSAs have been a hit with Canadians since inception. TFSA contributions surpassed RRSP contributions for the first time in 2012 and haven’t look back. Anyone who’s 18 years of age or older can contribute to a TFSA (you don’t even have to have earned income).
The TFSA contribution limit for 2016 is $5,500 (it was briefly $10,000 in 2015, before being scaled back in 2016). Although you don’t receive a refund for contribution to your TFSA, you don’t pay any income tax on any money made inside your TFSA. Unlike your RRSP, if you withdraw money from your TFSA, contribution room is restored the following year. Similar to RRSP, TFSAs can hold a variety of investments.
Should I contribute to my RRSP or TFSA?
There are a couple cases when it makes sense to choose your TFSA over your RRSP. If you’ll be in a higher tax bracket when you retire, the TFSA is the clear winner. For example, if you have a company pension plan, your RRSP could push you into a higher tax bracket. It can even cause Old Age Security to be clawed back. In this case, go with your TFSA.
TFSAs also make sense when you expect to be in a low tax bracket in retirement. A lot of people assume RRSPs make sense for everyone, when that couldn’t be further from the truth. If you’re in a low tax bracket, RRSP withdrawals can cause means-tested government benefits like Guaranteed Income Supplement to be clawed back. This is the equivalent of a 50 percent tax on your money. Ouch! As a general rule of thumb if you’re also currently in a low tax bracket and earning less than $40,000 per annum RRSP’s may not necessarily reduce your taxable income by much, so a TFSA might also better.
There are also several factors as to which one might be better, it all depends on your individual or family circumstance. If you’re unsure about whether you should contribute to an RRSP or TFSA, feel free to contact our office. We can take a closer look at your finances to see which makes the most sense for you.