Are you wondering where to put your savings, and confused about which account works best between a registered retirement savings plan (RSP) and a tax-free savings account (TFSA)?
For older clients, contributing to the TFSA is usually the smarter option. But for younger clients, it can be a tougher call. When deciding whether to save with either or both accounts, consider the following:
Tax Advantage
Taxes on contributions to your RRSP are deferred, and you will pay taxes to the Canada Revenue Agency (CRA) when you withdraw from the account in retirement. Although contributing to the TFSA does not reduce your current year taxes, it is a great account for earning tax-free investment income.
Current Income
Your taxes may be high if you currently earn significant income with few tax deductions and credits. In this case, you can use contributions to your registered retirement savings plan to claim the RRSP tax deduction thus reducing your taxes.
Future Income
If like most retirees, you fall within a lower tax bracket when you retire than when you were working, you should contribute to an RRSP to reduce your taxable income. However, if your taxable income in retirement will also be high, you should consider contributing to your TFSA and growing your money tax-free.
Contribution Room
The 2022 TFSA limit is $6,000, and your contribution room accumulates if you do not use all of it. Thus, if you have never contributed to your TFSA, your limit in 2022 is $81,500. The 2022 RRSP limit is $29,210. The CRA calculates your deduction room as the lower of this annual limit or 18% of your previous year’s earned income.
You must have contribution room to contribute to a registered retirement savings plan or a tax-free savings account. If you have used up your TFSA contribution room, then put your money into an RRSP and vice versa.
Closing Your Account
You can always keep your tax-free savings account open for life. For RRSPs, you must close them when you turn 71. When you close an RRSP account, you can withdraw your money and pay taxes or convert the account to an annuity or a retirement income account, such as the registered retirement income fund (RRIF). You are then required to withdraw government prescribed amounts, on an annual basis, which will be included in your taxable income.
Estate Consideration
When opening either a TFSA or RRSP ensure that you designate a beneficiary in order to avoid probate. In case you are leaving your TFSA to your spouse, designate them as the successor holder rather than beneficiary so that the account can rollover to them without triggering any tax consequences.
Disclaimer: This article is for general information purposes only, and is not legal, financial, or tax planning advice. Everyone’s situation is unique, and this article cannot apply to every person. The reader should not take any action, or refrain from taking any action, as a result of this article without first obtaining legal or professional advice. For further information you can consult: www.canada.ca/en/revenue-agency
