A recent BMO Financial Group survey concluded that 40% of Canadians don’t know the difference between a TFSA and RRSP.
Both are effective long-term savings vehicles that used properly, can save you a lot of tax. They both have some similar attributes but they also have some big differences and each one may be more appropriate for you than the other, depending on your situation.
One of the major differences is that RRSPs (Registered Retirement Savings Plans) have big benefits up front if you have tax to pay. If you’re in the 30% tax bracket, a $5,000 RRSP contribution will reduce your taxes by $1,500. By contrast, a contribution to a TFSA (Tax Free Savings Account) doesn’t give you any tax deduction up front.
For both types of accounts, as long as the money remains in the account, hopefully for many, many years, you will not have to pay tax on any growth or income generated on your investments. If you had your investments outside of either an RRSP or TFSA in a non-registered or OPEN account, you would pay tax each year on any interest, dividends or realized capital gains.
Another major difference is on the back-end – when you withdraw money from your account. With an RRSP, in most cases you would convert that to a RRIF (Registered Retirement Income Fund) when you retire or, at the latest, in the year you turn 71 and you would start drawing an income from it. Every dollar you withdraw from an RRSP or RRIF is income and taxable in the year it’s withdrawn.
With the TFSA, because you have already paid the tax on the amounts contributed and it has grown tax-free while in the TFSA, any amounts withdrawn come out completely tax-free. So, in an emergency, you could withdraw from your TFSA without any tax consequences. Remember though that the real tax advantages to be had with a TFSA are over the long term.
So which plan is the best for you to contribute to? Much of that depends on your taxable income. If you are in a high tax bracket, a contribution to an RRSP will give you a good immediate tax break. If you’re in a lower tax bracket or you won’t have any tax to pay, the TFSA may be best for you.
If you would like more information about either of these options, please contact us at 604-737-8886.