Both accounts allow you to contribute up to a maximum amount for each tax year. You can top up anytime. You can invest these funds however you like. Both types of accounts allow you to invest your contributions within them in a wide range of qualified investments such as stocks, mutual funds, exchange-traded funds ETFs and term deposits. However, some investments are better suited for RRSP or TFSA accounts than others — you may wish to get guidance from a financial advisor before investing.
You can reduce your taxes. Both of these savings vehicles offer tax incentives — but in very different ways. The key difference is in how each account treats contributions and withdrawals. The amount you contribute can be deducted from your earned income in the year you claim it up to your maximum contribution room for income tax purposes.
This may result in a tax refund for you. Investments are tax sheltered until you withdraw. So long as your savings are left inside an RRSP account, investments can grow tax-free. RRSP withdrawals are treated the same as other pre-tax income, however, and are fully taxable. You can dip in for a down payment or studies. You can access limited amounts tax-free in an RRSP for certain uses, provided you repay the money over time.
The drag from taxes can be significant. This can be avoided by using an RRSP. For more details check out the graphs below to see how the investment balance grows between the different accounts. Contributions can be made during high tax years and withdrawals can be made in low tax years.
RRSPs turn all kinds of income into ordinary income. Any money earned in an RRSP is considered ordinary income when withdrawn. This ordinary income gets taxed at your marginal tax rate. RRSP withdrawals can impact government benefits in retirement.
RRSP contribution room will never come back. RRSP contribution room is based on your gross income. TFSAs on the other hand always accrue the same amount of contribution room regardless of income. RRSP contributions can only be made using your own earned income.
These minimum withdrawals must be made regardless if you need the income or not. These mandatory withdrawals can create a tax burden that must be managed properly to avoid unnecessary taxes. If you spend your tax return rather than save it then watch out! The most efficient way to use an RRSP is to make pre-tax contributions. If contributions are made with post-tax income then you get a tax refund when you file your taxes at the end of the year.
This is a huge risk for many people who spend their tax return each year. You pay tax when you eventually withdraw money from an RRSP so its very important that the tax refund you get today also gets saved. Otherwise you essentially get hit twice, once now when you spend the refund, and once again in the future when you pay tax on withdrawal. I make less than 40K per year but I save a lot of it. I thought if I continued to make less than 50K per year that it would make sense to use my taxable account instead.
Hi Emily, this is an excellent question and the answer will very much depend on a number of different factors. Each situation may create opportunities to maximize your long-term wealth. Choose wisely. Sign up to receive the daily top stories from the Financial Post, a division of Postmedia Network Inc.
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