TFSA vs. RRSP: Which Is Better For Me?
Whether you’re a recent college graduate or an established professional, it’s never too early to start preparing your retirement strategy. As one might expect, the longer you live, the more resources you may need to sustain your lifestyle - meaning many Canadians benefit from starting to save sooner rather than later.
When preparing for your retirement, there are two common types of savings plans you could invest in: a Tax-Free Savings Account (TFSA) or a Registered Retirement Savings Plan (RRSP). When reviewing some of their key differences, it’s important to ask yourself, “When is the most advantageous time to pay tax on my income?”
What’s the Difference Between a TFSA and RRSP?
When beginning the decision-making process, it’s important to determine how you prefer your contributions to be made. For example, the contributions you make to your TFSA use after-tax dollars. The maximum amount you can contribute to your account changes yearly, with the 2021 TFSA annual contribution limit being $6,000.1
In regards to the RRSP’s tax implications, consider whether your tax rate during your retirement may likely be higher or lower than the current amount of taxes you’re paying each year. With the RRSP, your contributions are tax-deductible, but your eventual withdrawals will be taxed like income. Due to this, you want to consider whether you may be in a lower tax bracket when you’re withdrawing.2
If you’re concerned about when you’ll be able to take money out of your retirement account, there are aspects of the RRSP specific to retirement that aren’t found in the TFSA. This could make the TFSA more appealing to those who may want to withdraw (tax-free) from their savings for shorter-term savings goals.
Weighing Your Choices
While the TFSA and RRSP share similarities, such as being a way to save and invest your money, one of the key differences between the two vehicles surrounds suitability for your income. Unlike a TFSA, the RRSP may be more effective if you have a higher income and, subsequently, are in a higher tax bracket. In this instance, an RRSP may help to manage the impact of your tax deduction as you’re saving.
For people who are eager to withdraw their RRSP contributions, it’s important to note that early withdrawals may have the potential to hurt you financially. Technically, you can withdraw as long as you’re not in a locked-in plan, but these withdrawals will be taxed as income. Because you’re required to withdraw these funds at the end of the year you turn 71, you may want to consider steadily reducing your balance and list the distribution amount as part of your income during tax filing season.2 This could be a deal-breaker for those who would like to contribute to their savings plan with no limits or restrictions.
Education Is Key
When it comes to choosing between a TFSA and RRSP, there is no right answer. Everyone is going to have a different preference depending on when they want to pay their taxes, withdraw their distributions and more. However, it’s important to compare the pros and cons of each before making a decision if you want to make the optimal choice for you and your family.
Preparing for your retirement may seem like a daunting task, but deciding which retirement plan suits your needs the best is the first step to securing your assets, future and well-being for the coming years. Whichever decision you make, it’s important to understand that our needs are constantly changing, so be sure to not only think about your current preference but also what you might prefer in the years to come. As always, work with your trusted financial professional to develop a retirement savings strategy that works well for you today and for your goals toward retirement.