When Tax Free Savings Accounts (TFSAs) were introduced in 2009 Canadians were presented with another tax saving tool. This choice has created a perennial challenge - which is the best option - a Registered Retirement Savings Plan (RRSP) or a TFSA? The truth is they can work together in helping you achieve your financial goals. By contributing to both plans can help you maximize your tax savings. But emphasizing one option over the other can make sense, depending on your current circumstances, future plans, and overall financial strategy.
Here is a quick summary of the benefits and considerations of each option.
Registered Retirement Savings plans
An RRSP is an investment account that is designed to help you save for retirement. The features of an RRSP include:
1. Contribution limits
RRSP contribution limits for Canadians continue to increase every year. Your allowable contribution is 18% of your earned income from the previous year to a maximum of $26, 230 for 2018. You may also be able to tap into any unused contribution room you have carried forward from previous tax years.
2. Contributions are tax deductible
Allowable contribution is deducted from your gross taxable income for the year and you may end up with a tax refund (which many recommend putting right back into your RRSP for next year or even a portion into your TFSA). This makes an RRSP an ideal first choice for savings especially for high-income earners.
3. Defer the taxes
Income tax paid on RRSP investment growth is deferred until you start income payments in your retirement years. RRSPs must be converted to a Retirement Income Fund (RIF) after age 71. Withdrawals from RIFs are fully taxable, as such, annual withdrawal amounts may reduce government Old Age benefits. Those with a rich pension plan, working in retirement or major sources of alternative income, may want to consider additional savings options, such as a TFSA, in consultation with a financial advisor.
Tax Free Savings Accounts
The Tax Free Savings Account (TFSA) is an all-purpose way to invest as it can be used to save for any financial goal. The features of a TFSA include:
1. Contribution limits
As of January 1, 2019, if you have reached the age of majority, you can contribute up to the maximum annual amount of $6,000. Any unused contribution amount can be carried forward to future years.
2. Tax free
Your annual contribution is not tax-deductible and any growth in your TFSA investments is sheltered from taxation even when money is withdrawn. You can withdraw TFSA money without paying tax at any time and, best of all, the full amount of any withdrawals can be put back into your TFSA in future years (but not the same year).
3. Impact of eligibility on government benefits
Income earned in a TFSA and amounts withdrawn do not affect your eligibility for federal income-tested benefits and credits, such as Old Age Security or the Canada Child Tax Benefit. As well, unlike the RRSP, you don’t have to withdraw any money from your TFSA after age 71, so it is a great savings tool for seniors.
4. Estate considerations
You can set up the account’s assets to transfer directly to your spouse or common law partner upon your death, as long as he or she is named beneficiary on your TFSA.
The RRSP continues to make good sense as a first savings option for many investors. However, a TFSA offers interesting investment opportunities for high income earners, those nearing retirement as well as seniors. It may also be valuable to investors with lower incomes or those needing to access cash at any moment without penalty.
We can help
At Edward Jones, we can help you achieve your financial goals. A financial advisor can show you how TFSAs and RRSPs can provide you with plenty of flexibility in terms of savings opportunities and the capability to access money for emergencies. Contact your local Edward Jones advisor about a financial strategy that makes sense for you.