A common question for Canadian individuals starting their investment journey is whether they should invest in an RRSP (Registered Retirement Savings Plan) or a TFSA (Tax Free Savings Account).
Both alternatives will help you save on taxes; however, depending on your financial situation, one will prove to be more advantageous than the other.
When is an RRSP better?
When investing through an RRSP, tax is saved on a tax-deferred basis. This means that you still owe taxes; however, you will pay that specific tax at a later date.
The tax-deferral is achieved by tracking your contributions and withdrawals from your investments. Contributions are deducted from your income for tax purposes and withdrawals are added to your income for tax purposes.
For example, if you made $100,000 this year and chose to invest $10,000 in your RRSP, you will be taxed as if you made $90,000 of income for the year.
Now let’s say you are still making $100,000 the next year and chose to withdraw $10,000 from your RRSP, you will be taxed as if you made $110,000 for the year.
Although you still must pay tax on that $10,000 you contributed and then later withdrew that amount, the key is the timing of your withdrawals and contributions.
An RRSP is generally more tax advantageous when:
When is a TFSA better?
When investing through a TFSA, no tax is owed at all, meaning that investment income which you generated is tax-free.
A TFSA operates on a much simpler basis as opposed to an RRSP, yet unlike an RRSP, no tax deduction benefits are provided for a TFSA.
A TFSA is generally more tax advantageous when:
To conclude, it is important to note that whether you contribute to an RRSP or a TFSA, they are not investments in and of themselves; therefore you should consider your financial goals. You would still need to invest through your bank or trading account to have your investments channeled through an RRSP or a TFSA account which are then registered with the Canada Revenue Agency (CRA).
It is imperative to highlight that there are limits for each RRSP and TFSA in terms of how much can be invested in a specific year. This discussion is outside of the scope of this article.
Want to learn more about maximizing your wealth and what tax planning options are available to you? Contact us at email@example.com or 416-226-9840.