You may be wondering whether you are better off putting your money into a Registered Retirement Savings Plan (RRSP) or a Tax-Free Savings Account (TFSA). The answer is simple: it depends.
Whether to invest in an RRSP or a TFSA depends on many things including your objectives, what life stage you are at, your anticipated tax rate after retirement, and how much flexibility you would like with your investment.
RRSPs were created specifically as a retirement tool. With the exception of withdrawals made under programs like the Home Buyer’s Plan or the Lifelong Learning Plan which must be repaid to the RRSP over a specified period of time, taking money out of an RRSP prior to retirement can result in significant tax implications. What an RRSP lacks in flexibility, however, it makes up for in tax deferment. Contributions to an RRSP can provide a much-welcome tax break for some people during their earning years and can help incent them to invest more and earlier. For many, the immediate gratification of the tax deduction will guide their decisions but there are other things to consider. For example, because money in an RRSP is fully taxable at your marginal tax rate when it is withdrawn, it can lead to a reduction in income-tested benefits such as Old Age Security (OAS) if they reach a pre-determined threshold – currently $67,688. The clawback by itself is not a reason to avoid RRSPs but it should be enough to get people thinking about a strategy for managing their future income. Until recently there hasn’t really been a valid RRSP alternative for investing your money. The TFSA has changed that.
With TFSAs, unlike RRSPs, money that is invested does not provide a tax deduction and money withdrawn (including any earnings) is not considered income and therefore there are no tax implications, which make TFSAs useful for short-term savings. People must be careful with their contributions as excessive short-term activity can lead to accidental over contributions.
The fact that any earnings within the TFSA are exempt from tax makes them a great long-term option as well. The longer the investment horizon, the more time it has to grow which may mean a bigger pool of tax-free money to draw on down the road. An additional benefit is that because the withdrawals do not count as income, they will not cause a reduction in any income-tested benefits, such as OAS.
Both options offer benefits. How much should be invested in each will depend on many factors but the first consideration will be your objective. If you require flexibility for short-term goals, a TFSA will likely be the better option. For longer-term investment goals an RRSP/TFSA combo may be better. In most cases people will have multiple goals and their savings and investments need to be allocated accordingly.
Speak to your advisor if you have any questions about a Tax-Free Savings Account. You can also visit the Government of Canada website at http://www.tfsa.gc.ca, where you will find useful information about a Tax-Free Savings Account.
Any amount that is allocated to a segregated fund is invested at the risk of the contract holder and may increase or decrease in value.
INFOSTORELinks to valuable information directly from sources such as CRA and the Bank of Canada
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