This is a much debated subject when discussing investing. Both are great saving and investing options, but they come with important differences. Choosing between either a Tax Free Savings Account (TFSA) or a Registered Retirement Saving Plan (RRSP) can save you thousands over the long haul if you understand the differences.
Ideally everyone should maximize both, but for most of us, “life happens”; the car breaks down, the dishwasher or furnace quits, or some other financial emergency happens and the money we planned to save got reallocated. This is a good reason to set up monthly deposits to either plan. This way, the money’s out of your bank account before it can be spent elsewhere.
A number of people still make their RRSP contributions in January or February to get the tax deduction, often by way of an RRSP loan. There are better ways to make your RRSP contribution, especially because you can’t deduct the loan interest. Regular monthly investing into either an RRSP or TFSA makes a lot more sense, especially if into equity investments offering greater long term growth potential.
So, let’s review the pros and cons of each savings option. They both allow you to grow your investments tax free, into a wide range of investment options. The RRSP is the older option, introduced in 1957. RRSP contributions are made by way of pre-tax income and grow tax-deferred until withdrawn. They are then fully taxable as income. Any unused contribution room previously earned is carried forward and reported on you annual Notice of Assessment and can be caught up in a different year if funds are available. For 2018 the maximum allowable contribution room is 18% of last year’s gross income and capped at $26,230. Ideally, contributions should be made when in a high income tax bracket and withdrawn when in a lower tax bracket once retired. You can borrow from your RRSP in two ways; by way of “The Homebuyer’s Plan” to a maximum of $25,000 or a “The lifelong Learning Plan” at $10,000 a year up to a maximum of $20,000.
TFSAs are the more recent savings plan introduced in 2009 for anyone 18 years or older. Initially, the allowable annual maximum was $5,000, then $10,000 for one year and then moved down to $5,500. So, for someone who was 18 in 2009 and who has not started a TFSA, they could catch up the full $57,500 allowable contribution room for 2018.
You contribute after-tax money to a TFSA, so you don’t get a tax refund. But you can withdraw the money at any time, tax-free. If you withdraw money and your contribution room is used up, you can’t put contributions back into your TFSA until the next year, but you do not lose that contribution room like you do with an RRSP.
Based on the substantial amount that you can now invest in a TFSA, don’t waste this savings/investment opportunity in so-called “high interest” savings accounts. Remember, a TFSA can be invested in anything from GICs, mutual funds to stocks. For long-term investing, consider a balanced equity portfolio with substantially better growth potential.
Watch for Part 2 next week. To recap remember:
RRSP = pre-tax dollars invested, taxed when you withdraw. Grows tax free.
TFSA = after tax dollars invested, no tax when you withdraw. Grows tax free.
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