Have you spend time wondering whether to choose between TFSA vs RRSP? Now is the time to analyse your needs and decide.
So what is TFSA AND RRSP?
TFSA is a Tax-Free Savings Account and is basically an account that does not charge taxes on any contributions, interest earned, dividends or capital gains, and can be withdrawn tax free. Tax-free savings accounts were introduced in Canada in 2009 with a limit of $5,000 per year, which is indexed for subsequent years. The contributions are not tax deductible and any unused room can be carried forward. This savings account is available to individuals aged 18 and older and can be used for any purpose.
A Registered Retirement Savings Plan (RRSP) is a retirement savings and investing vehicle for employees and the self-employed in Canada. Pre-tax money is placed into a RRSP and grows tax free until withdrawal, at which time it is taxed at the marginal rate. Registered Retirement Savings Plans have many features in common with 401(k) plans in the United States, but also some key differences.
RRSPs have two main tax advantages: Contributors may deduct contributions against their income. For example, if a contributor’s tax rate is 40%, every $100 he or she invests in an RRSP will save that person $40 in taxes, up to his or her contribution limit. Basically investments under RRSPs compound at a pretax rate.
The Government of Canada has provided this tax deferral to Canadians to encourage saving for retirement, which will help the population rely less on the Canadian Pension Plan to fund retirement.
The benefits of a TFSA however come from the exemption of taxation on any earned income from the investment. A registered retirement savings account (RRSP) is for retirement, while a TFSA can be used to save for anything else.
The tax-free savings account differs from a registered retirement account in both deposits and withdrawals. Deposits in a registered retirement plan are deducted from your taxable income while deposits into a TFSA are not tax deductible. Similarly, while Withdrawals from a retirement plan will be fully taxed according to that year’s income, Withdrawals from a TFSA are not taxed. Both these accounts are very similar to each other, yet completely different in their functioning.
While both are great for your investments, choosing one over the other is not essential as you can have both coexisting if you monitor them. Remember that both TFSA and RRSP allow you to protect your investments from taxes and help your investments grow. Focussing your investment attention on one over the other can be beneficial in the long run.
Using an RRSP is a great way to keep money away from you; in short if you want to save up and don’t want immediate access to your cash, this is the route to go since a withdrawal will be taxed.
However a TFSA is a lot more flexible and can allow you to withdraw money if you end up needing it without any penalty. TFSA investments have already been taxed, so you won’t get any rude surprises when retire.
We hope this article helped you decide which one of these investment methods suits your requirements best.
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