TFSA vs. RRSP: Understanding the Difference and Maximizing Tax Benefits
TLDR: TFSAs allows your holding to grow tax free and withdraw them tax free, however you don’t get a tax deduction for contributing to them. RRSPs contributions are tax-deductible and allows your holding to grow tax free but are taxed once you withdraw from it.
Savings!
Saving for the future (or retirement) is an important financial goal for many Canadians, but deciding on the available saving accounts can be overwhelming. Depending on your future and tax planning goals, utilizing one account over the other could save you thousands over your lifetime. The two most popular options are the Tax-Free Savings Account (TFSA) and the Registered Retirement Savings Plan (RRSP), with each offering their unique benefits and drawbacks in tax planning. Let’s explore the differences between TFSA and RRSP, how they relate to taxes and how you make the most of these savings vehicles.
What is a RRSP? Tax Deferral and Retirement Savings
The RRSP was specifically by the Canadian government for retirement savings and offers immediate tax benefits for contributions. Unlike a TFSA, Contributions made to an RRSP are tax-deductible so reduce your taxable income that same year. These deductions you receive can result in a lower tax bracket and if your lucky, a tax refund!
Like an TFSA, RRSPs have contribution limits and any unused contribution room from previous years can be carried forward to this year. However, unlike an RRSP, is starts when you start earning income and it is unique to each person. The limit each year is normally 18% of what you made last year to a maximum of $31,350.
Where the RRSP losses points is what happens when you withdraw from them. These withdrawals are considered income to the CRA and will be added to your taxable income. However, withdrawals from an RRSP are taxable as income, so you'll have pay tax on any funds withdrawn from your RRSP.
What is a TFSA?Tax-Free Growth and Flexibility
The TFSA allows Canadians to contribute their after-tax dollars to a savings or investment account with any growth or withdrawals from the account are tax-free. The fact that you are able to withdraw from the TFSA at anytime tax-free makes it’s greatest feature.
Although this is an incredible asset, a disadvantage to the TFSA is that TFSA contributions are not tax-deductible. In other words, the funds you put into the account will not give you an immediate tax benefit for contributing into it. Unlike the RRSP.
Everyone above the age of 18 is eligible to a contribution limit that the vary each year. Over contributing to your TFSA results in a 1% per month fine on your over contribution. On the flip side, unused contribution room is carried over to the next year. Furthermore, when you withdraw money from a TFSA, that same amount is added back to your contribution limit at the start of the next calendar year. Your contribution limit starts building the year you turn 18 or the year you become a Canadian Citizen, whichever is more recent.
For example, if you withdraw $2000 from you TFSA this year, you will gain the same $2000 in your contribution room starting Jan 1st next year! Plus, your contribution limit is raised once again.
How do they relate to tax planning?
Choosing between a TFSA and RRSP can have significant outcomes for your tax planning strategy.
For example, you could get larger tax savings by contributing to an RRSP within your prime income years and withdraw your funds later on during your lower income years are a lower tax rate.
On the other hand, if you have a shorter-term goal or tend to make less than $50000 a year, you may be better off contributing to a TFSA since your contribution limit isn’t tied to your earned income and withdrawing creates extra contribution room starting next year.
How can we help?
A.B.T PRO INC. understands the complexities of tax planning and can help you make better and informed decisions about saving for the future. We will work closely with you to assess your goals and develop a customized tax planning strategy that maximizes the benefits of both TFSA and RRSP.
