When it comes to choosing whether to contribute to a Registered Retirement Savings Plan (“RRSP”) or Tax-Free Savings Account (“TFSA”), the debate tends to centre on which one is the superior savings vehicle. In an ideal world, you would contribute to both. In the real world, life can get in the way and you may not have enough funds available to do so. While building your nest egg is important, it may make sense for you to take full advantage of one plan type over another based on your income, financial goals and future plans.
Use the following as a guide to help you determine your savings strategy:
- If you are in a higher tax bracket
RRSPs allow you to reduce your taxes payable now and potentially in the future. That’s because RRSP contributions can be deducted from your income, decreasing your present-day tax bill and setting you up to pay less tax later, assuming your income level is lower in retirement. You can also bolster your TFSA with any tax refunds to protect even more of your savings from the tax man.
- Saving for short-term versus long-term goals
By their very definition, RRSPs are for long-term goals – namely retirement. Left untouched, an RRSP can benefit from tax-free compounding, with money growing tax sheltered as long as it is kept within the plan. When an RRSP is finally converted to retirement income, it is taxable. However, at this point your marginal tax rate is likely lower than it was during your earning years.
TFSAs work differently. Contributions aren’t tax deductible since they are made with after-tax dollars, but you pay no tax on withdrawals. For that reason, a TFSA can be good for financing short-term goals, like renovating your home or buying a new car.
- Defining your savings objectives
A TFSA offers more flexibility in terms of access to funds. You can withdraw with no tax penalties. In fact, TFSAs and RRSPs can be used in tandem to help you reach your savings goals. One approach is to supplement your TFSA while you determine how you want your future to look – you always have the option of transferring your money to your RRSP at a later time without tax consequences.
Both work well
Whichever way you look at it, TFSAs and RRSPs can be great for savers. If possible, take advantage of these vehicles and make the most of the unique characteristics of each. Both offer significant benefits to help you reach your financial goals and they can both play a role in your wealth strategy. Please keep in mind that there are situations in which one may be more appropriate than the other. To assist you in deciding when best to use an RRSP and TFSA, review our convenient infographic.
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