Planning for your future is a critical part of the present but trying to decide on a savings plan can be tricky when you do not know all the facts. It’s integral to include other factors in your decisions concerning your savings. Taking a closer look into things like your current financial situation, your long- and short-term goals and their tax impact are all elements that can affect your choices. One of Oasis LLP’s missions is to ensure you are aware of tax strategies that can help in building your wealth.
For Canadians, there are several different savings tools available. The one that is right for you will depend on your own savings goals. The two most common savings opportunities are the Tax Free Savings Accounts (TFSAs) and the Registered Retirement Savings Plans (RRSPs). While the best and easiest option might be to opt to put the maximum allotted contribution into both types of accounts, this is simply not an attainable course of action for a majority of Canadians. This is because it requires a large amount of disposable income.
The significant difference between RRSP and TFSA is how they are taxed when you contribute and withdraw.
With RRSP, you get a tax deduction when you contribute, and you pay tax when you withdraw (there are some exceptions like Home Buyers’ Plan or Lifelong Learning Plan).
With TFSA, you do not get a tax deduction when you contribute, and you are not taxed when you withdraw.
Generally, RRSP is intended for long-term goals, for example retirement; while the TFSA is designed with flexibility to accommodate short-term goals.
So, which is the best for you? Keep reading to find out more.
Age
If you are over the age of 71, then your RRSP will have collapsed, and you can no longer make any contributions. This means that if you want to put money away for a rainy day, it will have to go into a TFSA as the only tax-free savings option available for you. You will be able to make tax-free withdrawals and contributions will not reduce your taxable income like money withdrawn from an RRSP or RRIF (Registered Retirement Income Fund).
If you are younger and have high employment income, RRSP is one of the best, and the only, way to reduce your employment income and, therefore, lower taxes. Increase your savings by contributing any tax refund into your RRSP.
Registered Pension Plan (RPP) Members
If you contribute to a RPP through your employment, this affects your RRSP contribution room. Your yearly RRSP contribution maximum is 18% of last year’s income. This maximum is also reduced by amounts accrued in the current year under your RPP. If your RPP is high, then your RRSP contribution room may be seriously reduced or even nonexistent. If this is the case, a TFSA might be the best option.
Short Term VS Long Term Goals
Many young Canadians have short-term goals. These are characterized by things that might happen in the near 5-year future, such as buying a car or getting married – or both! A TFSA is the best option for those individuals that this applies to.
This is because even though you can withdraw money anytime from your RRSP, these withdrawals are taxable, which will increase your tax owed during the year of withdrawals. This might be offset by tax savings during the year of contribution; however, increases in income within those five years could result in a greater amount of tax paid in the end.
Another factor is that once funds are withdrawn from your RRSP, those funds cannot be replaced, and you will have lost a portion of your contribution space. This can make it harder to save up for your retirement.
On the other hand, TFSAs can offer tax-free withdrawals and allows you the option to replace any amounts which have been withdrawn in the following year.
If your short term goal includes buying your first home or going back to school, you can still contribute to RRSP. The Home Buyers’ Plan (HBP) is a program that allows you to withdraw up to a maximum of $35,000 tax-free from your RRSP to buy a home. You do have to pay this amount back and your repayment starts the second year after the withdrawal, and it is repaid over 15 years. The concept with Lifelong Learning Plan (LLP) works in a similar fashion in which it allows you to withdraw up to $10,000 for you or your spouse or common-law partner and allows you 10 years to repay it to your RRSP.
Income Splitting
TFSA is one of the best options for you if you want to income-split the money you earn on investments with your spouse or common-law partner. You can give your spouse money so that they can invest, and the earnings will not be attributed back to you. The earnings and the withdrawals made by the spouse is tax-free.
You can do something similar with an RRSP – make a spousal contribution. The contributions will result in a tax deduction for you, and when it is withdrawn, your spouse will be taxed. This is great if your earnings will be significantly higher than your spouse even in your golden years.
Government Benefits
Since TFSA withdrawals are not included in your income, they do not affect your eligibility for various government benefits such as Canada Child Benefit, Working Income Tax Benefit, GST Credit, Age Credit, Old Age Security (OAS) benefits, Guaranteed Income Supplement (GIS) or Employment Insurance Benefits.
These are only some of the factors you need to keep in mind when choosing between a TFSA and RRSP. To find out which option would be the best for you, contact one of our advisors at Oasis LLP today.
The information contained within this blog is provided for informational purposes only and is not intended to substitute for obtaining accounting, tax, or financial advice from a professional accountant. Please contact Book an Appointment to discuss how information contained here pertains to you.
About Oasis LLP – Advisors and CPAs
At Oasis LLP we help business owners find what is at the end of the rainbow. With over 25 years of expertise in business advisory, accounting & auditing, and tax, we can help you navigate the accounting and tax world. We are located in Richmond Hill serving the Greater Toronto Area.
