Whether you’re new to the savings game or a seasoned veteran, staying on top of your money is no small task. From saving for your first home to funding your retirement, a Tax-Free Savings Account (TFSA) or Registered Retirement Savings Plan (RRSP) are the most common savings tools used by Canadians to save for their everyday financial goals. Both members of the savings family, RRSPs and TFSAs, are like siblings with different personalities. They both offer Canadians unique ways to save by evaluating theircurrent finances against your future goals. So, the question remains…should you save with an RRSP, TFSA, or maybe both?
What is a TFSA?
A Tax-Free-Savings Account, or TFSA, is an all-purpose savings plan that allows you to set aside money tax-free throughout your lifetime for a variety of savings goals. With a TFSA, you can hold several investments, including cash, GICs, mutual funds, stocks, and bonds. According to the Government of Canada, all Canadians 18 years of age or older with a valid social insurance number (SIN) can open a TFSA.
Benefits of a TFSA
A TFSA is not your average savings account. As the name suggests, contributions made to your TFSA and the interest earned on this income, are not subject to taxes. This all-purpose savings plan also offers Canadians the flexibility to withdraw funds for any occasion without paying a tax penalty. This gives you the peace of mind that your money is instantly available to you if you need it. So, if you are looking to pay for a long-overdue vacation, purchase your first home, or build an emergency fund, you can instantly access your funds with a TFSA and get even closer to reaching your financial goals. Plus, any interest, capital gains, and dividends earned on your TFSA investments are tax-free throughout your lifetime.
Contributions to your TFSA have a ceiling, also known as a contribution limit, which determines how much you can add to your tax-free savings account each year. The annual contribution limit for 2023is $6,500 . Unable to make your full contribution this year? Not to worry! Any unused contribution room can be carried forward into future years indefinitely, giving you even more chances to contribute. Be careful to not over-contribute, as you’ll pay a 1% tax penalty equal to the highest excess amount every month that these additional funds remain in your account. So, if you over-contribute by $2,000, you’ll have to pay a tax of $20 every month.
What is an RRSP?
A Registered Retirement Savings Plan (RRSP) is a long-term saving vehicle designed to help Canadians build a nest egg for their retirement years. Your RRSP can hold a series of investments, including mutual funds, stocks, bonds, and GICs. RRSP contributions reduce your taxable income, which means more cash in your pockets to help you retire comfortably later.
Benefits of an RRSP
Anyone who earns income is eligible to contribute to an RRSP until the age of 71. RRSP contributions are capped at 18% of your earned income from the previous year for a maximum contribution limit of $30,780 for the year.Contributions to your RRSP are tax-deductible, which allows you to put money aside and get a tax break on your income at the same time.As a tax-deferred savings plan with an RRSP, you only pay taxes further down the road when it’s time to withdraw your money at retirement. Now, while RRSPs are a valuable tool for retirement planning, they have the power to do so much more! You can borrow funds from your RRSP to help you purchase your first home or even finance your post-secondary education or training if you meet the necessary requirements. With the Lifelong Learning Plan (LLP), you can withdraw up to $10,000 per year for two years from your RRSP to finance full-time education for you, your spouse, or your common-law partner at no tax penalty. Upon completing your education, you’ll have 10 years interest-free to return the money to your RRSP. The one caveat, recipients of the Lifelong Learning Plan cannot use it to finance their child’s training or education – consider a RESP to meet these needs instead. With the Home Buyers Plan (HBP), first-time homebuyers can withdraw up to $35,000 from their RRSP to put towards their first home and have 15 years to repay the funds to their account at no tax penalty.
Now, while you are required to be at least 18 years old to open a TFSA, you qualify for an RRSP at any age so long as you are earning income and have filed a tax return to create contribution room. So, if you are 16 years old and starting your first job at a retail or grocery store, consider putting your hard-earned pay cheque towards opening an RRSP and start funding your financial dreams today!
So… is a TFSA or RRSP right for you?
The truth is, both are great options to help you save and grow your wealth.
The case for the RRSP
Are you a seasoned working professional and able to afford to save but struggling to keep your hands out of your financial cookie jar? Putting money aside in an RRSP could be a viable option to help you protect your savings and prevent you from falling victim to impulse purchases. By contributing to an RRSP throughout your career, you’ll be able to utilize tax benefits that can reduce your taxable income as your income level grows. Similarly, by deferring withdrawals from your RRSP until retirement, you get to keep more of your money as you will be taxed at a lower rate than in your income-earning years. Plus, if you don’t max out your contribution room this year, any unused contribution can be carried forward to use in a future year.
The case for the TFSA
Now, if you are at the start of your career or making a modest income, a TFSA could be better for funding your short and long-term financial goals. The main attraction of TFSAs is the convenience they offer as you can withdraw your money anytime, tax-free. So, bring on that dream vacation or home renovation with the help of your TFSA!
Ultimately, in the great RRSP versus TFSA debate, there is no “right choice” – it’s about finding the savings plan that works for you. Whether you are looking to fund your retirement or make a large purchase, it’s vital to review your current finances against your needs for the future when choosing your savings plan. Visit your local credit union and speak with a financial advisor about your short and long-term financial goals to help you build a personalized savings plan – be it a TFSA or RRSP.
Make a credit union part of your savings strategy
Credit unions are an excellent option to help you save for your financial needs of today and tomorrow. Not yet a credit union member? Find your nearest credit union here.