Welcome to February

RRSP or TFSA?  Of course, contributing your annual maximum amount to both is best.  But many people have a hard time affording one let along two contributions annually.  So, what if you have to choose?  Which one is best?  Well, like a wise parent raising their children, not all answers are the same for everyone.  Let’s start with a quick refresher of what they are.

Both are government incentivised savings plans.  Meaning that the federal government provides incentives for tax payers to save in one of these registered plans.  Registered, means that the plan is registered with CRA through a trustee like a trust company or a bank or credit union.  At Drake Financial Ltd. we are agents for Olympia Trust and Canadian Western Trust and we can set up all types of registered accounts at our office and process your contributions and withdrawals.

RRSP Explained

The incentive for an RSP is that the contributor (that’s you) gets a tax break in the year of the contribution – excluding the first 60 days rule – meaning that in the first 60 days of the year you can make a contribution to your RSP for the previous tax year.  This is a great advantage because it is only a month or so from tax filing deadline and you can get your tax refund close to the date of your contribution.  Some people are fortunate enough to get enough in their tax refund to fully cover the RRSP contribution.  But I digress…the other tax incentive of an RRSP is that the interest or growth of your contributions, while in the plan, are not taxable, and so that allows for the plan to grow quickly.

You can withdraw your funds at any time but when you do the amount you withdraw is taxable as income in the year you withdraw it.  If you have a locked in RRSP or a spousal RRSP the withdrawal rules are restricted, you can ask me for specifics if you have one.  Once you turn 71 you will need to convert your RRSP to an RRIF by the end of the year in which you turn 71.  Then at age 72 the trustee will make a calculation of the amount each year you are required to withdraw – called your minimum amount.  It is a based on a calculation resulting in you withdrawing all your funds at the age of 90.  You can also choose to have the calculation based on your spouses age if he/she is younger than you are. 

So, who is best able to take advantage of RRSPs?  Generally, people with higher taxable income should prioritize annual RRSP contributions over TFSA contributions if they can’t make both.  The reason for this is that once retired most people’s income drops and therefore the person pays lower taxes by receiving the tax deduction from their higher income years, earning interest tax free while in the plan, and paying lower taxes when withdrawing at a later age.

TFSA Explained

The incentive for a TFSA is that the interest or growth of the funds in the plan is tax free while in the plan and this allows for higher real growth of the funds due to not paying taxes on the investment.  The other benefit of the plan is that you can pull funds out anytime without paying any tax on the withdrawn amount.  And you can put the funds back in the plan the next year – subject to the maximum contribution amount showing on your CRA notice of assessment. 

Who is best to take advantage of a TFSA? In rough terms, people who don’t have high income but have funds to invest. 

So, what is best, an RRSP or a TFSA?  The best answer is both.  But if you have to choose, then generally an RRSP is best if you are in your higher income earning years and a TFSA is best if you are not a high-income earner.

This article is general information and not specific.  If you want to discuss the best options for RRSP or TFSA, please contact me to discuss your personal situation.