Which One Is Right For Me?
Everyone wants to achieve financial security both for now and for the future. RRSPs and TFSAs are both excellent ways to save for the future, but deciding which one best suits your needs can be difficult. Both of these government registered savings vehicles provide tax-advantaged savings, but which option is best for you depends on a number of factors including your age, income, tax rate and future cash flow needs. By understanding the differences between these two options you can make the best decision for your current and future financial situations.
The Benefits of Registered Savings
Whenever you put money into a savings account, either registered or non-registered, it’s like planting a seed in the ground. Income is generated from investments held within a non-registered account, and is typically taxed every year. Gains in the value of investments that are held within a non-registered account are also considered taxable when sold. This is similar to pruning a tree, slowing its growth. Money held within an RRSP or TFSA is not taxed annually, and the difference can add up quickly. Registered accounts help you grow your money faster, like watering a tree. RRSPs and TFSAs are treated differently than non-registered savings accounts and this coupled with compounded growth, can make a significant difference to your investments over time.
The Tax Advantages of RRSPs
RRSP contributions give you a tax benefit up front. Every year you will receive a tax receipt for your contribution amount which offsets your income when you file your annual income taxes. It is almost like paying yourself twice: You pay into your savings plan which benefits your future self, and you get an immediate tax break which benefits your present self. Any gains in the value of your investments into an RRSP are tax deferred, so you only pay income tax when you withdraw the money from your RRSP at a later date. This is highly beneficial if you wait until you retire before withdrawing funds because you will likely pay less tax on it because your annual income is likely to be less than when you were working.
The Tax Advantages of TFSAs
TFSAs do not give an upfront tax benefit like RRSPs. Contributions to your TFSA are made with after-tax dollars, though any increase in the value of your TFSA is tax free. This means that you won’t pay any taxes on the money you withdraw later from your TFSA because you will have already been taxed on those funds.
Until what age can I contribute?
There is no minimum age regarding when you can start contributing to your RRSP fund but you cannot contribute to it after you turn 71. You must convert your RRSP funds into an income annuity or a registered retirement income fund (RRIF) by December 31 of the year that you turn 71.
In order to contribute to a TFSA you must be at least 18 years older, be a resident of Canada, and have a valid Social Insurance Number. You are able to make contributions every year after you turn 18.
What are the annual contribution limits?
You are able to contribute up to $24,930 or 18 percent of your earned income for the previous year, whichever is less. The RRSP contribution deadline for the 2015 tax year is February 29, 2016. Any contributions made after this date are counted towards the 2016 tax year, and the receipt issues for them will reflect that.
You are able to contribute a maximum amount of $10,000 to your TFSA for the 2015 tax year and there is no annual deadline for contributions.
What about unused contribution room?
Unused RRSP contribution room can be carried forward each year until you turn 71 and TFSA contribution room can be carried forward indefinitely. On January 1 of each year your contribution room for your TFSA resets. When you make your contribution next year you can catch up on any unused room, so if you only contributed $8000 this year you can contribute $12,000 next year – $10,000 for that year and the additional $2000 from the year before.
Which plan is best for me?
There are no set rules for determining which plan is better for you. Though both RRSPs and TFSAs are good choices for long term savings there are a few key factors you should consider when deciding: If you will need to withdraw funds in the near future then a TFSA is better suited to your financial needs. If you are planning on holding onto those funds until you retire then an RRSP might be a more suitable choice. If you are able to maximize your contributions on both accounts then doing so will help you achieve both your long and short term savings goals. If your financial situation means you must choose only one option then you should consider whether your income is likely to increase or decrease in the future. If you are just starting out your career and expect your income to increase you may consider contributing to a TFSA, which could also help with things like a down payment down the road. Contributing to an RRSP down the road will give you more contribution room when you are earning more, giving you a bigger tax break when your income is higher. If you are getting closer to the end of your career and expect your income to decrease when you retire then you may consider leaning more towards an RRSP which would let you pay less tax overall because you would not be taxed on these funds until you retired, putting you into a lower tax bracket.
The sooner you begin contributing to an RRSP or TFSA the greater its potential for growth because the interest you earn on the money in these savings vehicles is compounded. To decide which plan is best for your financial situation speak with your financial security advisor or investment representative.
Tim Lacroix of CGY Mortgage has been helping Calgarians achieve financial security for years. To find out how he can help you call today at 403.648.1541 and visit timlacroix.com