What’s the best way to save for retirement? Registered Retirement Savings Plans (RRSPs) are an obvious choice, but Tax-Free Savings Accounts (TFSAs) can play a role, too.
RRSPs and TFSAs are complementary tax-saving tools that can work together to help you achieve your goals. Deciding when to use an RRSP or a TFSA – and when you might want to use both – will depend on your life stage, family situation, tax bracket, investment goals and other factors unique to you. Here’s a handy look at the advantages of these account types and how to maximize the benefits of each, according to your circumstances.
Similar benefits, different taxation features
As tools meant to help you grow your investments, RRSPs and TFSAs share some common benefits. Both RRSPs and TFSAs can help you save for your short- and long-term goals and they also allow your investments to grow tax-free. Similarly, both TFSAs and RRSPs can hold a range of investment vehicles, such as stocks, bonds, mutual funds, cash and term deposits, and exchange-traded funds.
The main difference between an RRSP and a TFSA comes down to when you pay tax. With RRSPs, you’re deferring your income taxes into the future, which is why you get a tax credit when you make an RRSP contribution. Deferring income taxes until retirement can be beneficial if you anticipate being in a lower tax bracket in retirement since RRSP withdrawals are taxed like income.
With TFSAs, your contributions use after-tax dollars. While contributions aren’t tax-deductible from your income, you don’t pay any tax on withdrawals.
Optimizing your RRSP
An RRSP is ideal for achieving long-term goals – namely, retirement. It features higher contribution limits when compared to TFSAs, which allows you to benefit from tax-free compounding growth, so long as the money remains within the plan.
It’s also important to note that most early withdrawals from RRSPs can result in a hefty tax bill. The Home Buyers' Plan is one notable exception. This program allows first-time homebuyers to borrow up to $35,000, tax-free, from their RRSP for a down payment. Any withdrawals made through this program have to be repaid to the RRSP over the next 15 years, starting the year after the initial withdrawal.1
TFSAs offer greater flexibility
TFSAs offer an ideal way to plan, save and grow your money for short-term goals, such as a renovation or a vacation, because you can access the funds as you need them. Importantly, interest, dividends and capital gains earned in TFSAs aren’t taxed – regardless of how much they grow – which allows you to benefit from even more from compounding growth in your account.
Here are some other important factors to keep in mind:
- While RRSPs work well for those in high-income tax brackets, the versatile features of a TFSA are designed to help anyone – including mass-affluent investors – to supplement their retirement savings or to assist with other life goals.
- If you’ve already reached your RRSP contribution limit or have no room left because of a pension plan, contributing to a TFSA can give you another way to boost your tax savings.
- If you’re retired and cannot contribute to an RRSP, but still have money to invest, then TFSAs offer another way to grow your income.
- To fully benefit from RRSPs, be sure to reinvest your tax refund into your RRSP so that you can grow your money faster.
Saving for your future can be a lengthy process, but both TFSAs and RRSPs can offer valuable tax advantages to make it easier. For a helpful breakdown of their key benefits, please download our infographic.
It can be challenging to juggle saving for both your short- and long-term goals. I can help you build a financial plan that integrates your unique circumstances and leverages RRSPs and TFSAs. Let’s discuss your goals and how to best reach them by calling our office today.
1. Government of Canada, What is the Home Buyers' Plan (HBP)?