If you’ve made a New Year’s resolution to start saving at the beginning of the year, you may wonder what the best way is to save. The Canadian government has created two products for savings. A Tax-Free Savings Account (TSFA) is a registered product introduced in 2009. They presented it as an alternative to the Registered Retirement Savings Plan (RRSP), which was first introduced in 1957. So, is a TSFA or an RRSP better for savings?
What’s the Difference Between a TSFA and an RRSP?
The RRSP program allows savings to grow tax free until withdrawn, and the contributions are tax deductible in the year they are made. Withdrawals are limited and are added to your income in the year you withdraw them, resulting in a higher taxable income. There are programs which allow you to withdraw RRSP funds to use not only for retirement but also for post-secondary education (Lifelong Learning Program) or for buying your first home without affecting your taxable income. However, both programs demand the money be repaid to the RRSP or added to your income annually over the following 10 to 15 years.
TFSAs grow tax free, but the contributions are not tax deductible. There are no limits to the withdrawals, and you can use the funds for any purpose with no restrictions like an RRSP has.
For the current year, the RRSP contribution limit is 18% of your earned income (employment and business earnings) to a maximum amount of $27,830. The maximum limit is adjusted annually based on inflation. If you belong to a pension plan, contributions will reduce the eligible amount, but any unused contributions are carried forward. You can also use your own contribution room to add to a spouse’s RRSP, which provides immediate tax relief for you, and (hopefully) a lower taxable income upon withdrawal for your spouse.
TSFAs currently have an annual contribution limit of $6,000. Like the RRSP, unused contribution limits can be carried forward and used in future years. However, there is not an option or benefit to contributing to a spousal TSFA.
What Can Be Held in a TSFA or RRSP?
Legally, you can hold almost any investment inside both TSFAs and RRSPs. What is available to you depends on your financial institution? Consult your financial advisor about the options available. You may be able to purchase products beyond simple savings accounts and invest in higher return investments, such as mutual funds, stocks, or bonds.
Which Is Best for Me?
Is a TSFA or an RRSP better for savings? It depends.
RRSPs provide immediate tax relief, but upon withdrawal, all income is treated as earned income, so growth inside the RRSP may be taxed at a higher rate. (Dividends and Capital Gains receive preferential tax treatment). If your retirement income is higher than originally planned (because of pensions, Old Age Security, or ongoing post-retirement employment), then you may get no tax savings at all. RRSPs mature by the time you are age 71, then must be converted to a Registered Retirement Income Fund (RRIF), an annuity, or completely withdrawn.
TSFAs don’t provide any immediate tax relief. But at withdrawal, you don’t have to declare the income, so it won’t affect income-tested benefits such as the Guaranteed Income Supplement. And TSFAs are more flexible because they don’t mature, and you can use the funds for any purpose throughout your life without penalty.
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