RRSP OR TFSA? BOTH IF YOU CAN, SAY FINANCIAL ADVISERS
Canadians should explore retirement savings in both RRSP and TFSA vehicles.
Instead of debating the merits of an RRSP or a TFSA, Canadians should consider socking away money in both types of accounts for the best tax breaks, financial advisers say. But since that can be a challenge for most people, the decision of where to save boils down to what you want to use the money for, your income and how much you expect to earn in retirement. "In a perfect world, people would be maximizing both their RRSPs and TFSA contributions," said Susan Stefura, a certified financial planner with Bespoke Financial Consulting in Toronto. "But, of course, the world isn't perfect and most Canadians don't have the funds available."
Launched in 2009, Tax-Free Savings Accounts were created as a way to encourage Canadians to invest and save without paying taxes on those gains. In contrast, money socked away in an Registered Retirement Savings Plan generates a tax deduction when it is invested, but it may be taxed when it is withdrawn. Stefura suggests Canadians look at their tax rate and what they expect it to be in retirement. For those who are in a high income bracket and expect that their tax rate will be lower in retirement, an RRSP contribution will allow them to take advantage of the lower rate upon withdrawal without risking old age security (OAS) benefits. "But if your income is too high (in retirement), you won't get that tax benefit and it will clawed back," Stefura said.
Factors to consider that might affect your taxable income in retirement: receiving a generous pension and not having a spouse to take advantage of income-splitting rules, the sale of a business or property, or the expectation of a large inheritance. Certified financial planner Monique Maden notes RRSP contributions can only be made by Canadians until the age of 71, so older investors will want to consider a tax-free savings account if they have extra money to invest. Money held in TFSAs are tax-free and are not factored in when calculating old age security benefits. "All withdrawals from an RRSP count in the calculations, where the same amount of money taken from a TFSA isn't part of the OAS clawback because it's effectively out of the tax system," Maden said.
TFSAs can also provide more flexibility than an RRSP. That's another reason why a TFSA may be more attractive to young savers who want to have an accessible emergency fund or save up for a large purchase like a car or vacation, said Chris Buttigieg, a senior manager of wealth planning strategy with BMO Financial Group. "The TFSA makes sense early on because of the flexibility that they offer. You can make withdrawals at any time for any amount for any reason," he said.
Money can be taken out of an RRSP account before retirement but investors will be taxed on the withdrawl unless they are taking advantage of homebuyer or lifelong learning programs. In an ideal situation, Buttigieg suggests taking the tax refund from an RRSP contribution and investing it in an TFSA to maximize the financial benefits. "Use the two vehicles to complement each other so you can try to save as much as you can," Buttigieg said.
Canadians looking to make a contribution to an RRSP or a TFSA should be aware of contribution limits and tax implications upon withdrawal.
- You may contribute up to 18 per cent of your income up to a maximum of $24,930 in 2015. Unused contribution room can be carried over from year to year.
- The amount contributed to an RRSP is be deducted from your income, reducing the amount of tax you pay that year.
- If you withdraw from an RRSP account at any age, your financial institution will deduct a withhold tax that will be paid to the Canada Revenue Agency on your behalf.
- The withdrawals count towards your annual income for that year and are taxed as income.
- At age 71, Canadians have to decide whether they want to close their RRSPs and withdraw the money, which will count towards income and be subject to tax, or convert the plan into a registered retirement income fund (RRIF) and be subject to a minimum withdrawal each year.
- You can contribute up to $5,500 into a tax-free saving account this year. From 2009 to 2012, the contribution limit was up to $5,000. This amount was increased in 2013 to $5,500 a year.
- Unused contribution room can be carried over each year, so anyone over 18 years old as of 2009, who has not invested any money into a TFSA will be permitted $36,500 of contribution room in 2015.
- Withdrawals can be repaid in the following year, if the contributor has already hit their limit for that year or be subject to a penalty.
- Withdrawals from a TFSA, including any investment gains, are tax free.