With tax season in full swing we know many Canadians are trying to focus more so on their tax return as opposed to actually filing their taxes. Should you splurge on a long awaited purchase? Book a vacation? Or put money away? And if you do decide to save your tax return, what’s the best option? What are the differences between a Registered Retirement Savings Plan (RRSP) and a Tax Free Savings Account (TFSA)? Here is a simplified comparison to help you decide which plan is smarter to invest in.
Gail Vaz Oxlade, Author of “Debt-Free Forever” and financial planning TV show host, explains RRSPs in the perfectly simplified way. Vaz Oxlade says to place a $20 in a box, and place an umbrella over the box. The box is a savings account; the umbrella is the RRSP plan registration. This visual description helps us understand how the box (savings account) holds your money, and the umbrella (RRSP registration) protects your money from tax deductions (i.e. the rain). When you put money in an RRSP you’re shielding off the tax drizzle and allowing your money to grow by deferring deductions and getting a return for any payroll deductions already taken off that income.
A TFSA t is similar to an RRSP in that it is a savings account that is free of tax deductions, but it does differ from an RRSP in terms of flexibility and management. You have the flexibility to withdraw from and contribute to your TFSA whenever you want. But with great power comes great responsibility. You are the one who is responsible to make sure you are not over contributing to your TFSA in any given year. The government decides the maximum allowed contribution for every year and you cannot over contribute otherwise you will be penalized.
RRSP or TFSA?
Both savings options have their pros and cons; both protect you from tax deductions, both grow your money tax free, and both give you multiple ways to save including stocks, bonds, mutual funds and GIC’s. So how do they differ?
- RRSP’s defer tax deductions on contributions, they don’t eliminate them. When you make a withdrawal your money will be tax deductible. But the idea here is that you’ll be withdrawing the funds when you’re income is lower (retirement) and so the deductions will be fewer. With a TFSA your withdrawn funds are never taxed.
- The freedom given to you with a TFSA does have its drawbacks. Having your finds out of reach in an RRSP protects you from yourself in a sense. We all get into situations where we need or want to draw on our savings. With the exception of a first-time home purchase or schooling, your money is protected with an RRSP more so than with a TFSA.
So which option is better for you? They’re both beneficial in their own way, and in an ideal world you would contribute to both. One thing to consider when making your choice is your income bracket. If your income is on the very high or very low end, an RRSP contribution can affect government benefits such as the Canada Pension Plan, Old Age Security or the Guaranteed Income Supplement programs. Lastly, Gordon Pape – Canadian retirement author, suggests your age as a factor to consider, “you can’t have an RRSP after the age of 71, but you can have a TFSA for the rest of your life.”