Canadians have two great tools available for accumulating wealth, Registered Retirement Savings Plans (RRSPs) which were introduced in 1957 and Tax Free Savings Accounts (TFSAs) which were introduced in 2009.
We often get asked by clients which account type is better to contribute to, RRSPs or TFSAs. First, let’s look at the basic differences between the two:
- RRSP contributions are tax deductible (which results in you paying less income tax) but you have to pay tax on the money when you withdraw it.
- TFSA contributions are not tax deductible, but withdrawals are tax free.
- For RRSPs, 18 percent of the previous year’s income to a maximum of $24,930 in 2015 (less any pension adjustment.)
- For TFSAs, the 2015 limit is $5,500. If you haven’t contributed to a TFSA since they were first introduced your cumulative limit is $36,500.
- The last year that you can contribute to an RRSP is the year in which you turn age 71.
- TFSAs have no age limits.
So which one is better to contribute to? The short answer is: That depends.
In general, if you expect your income to be higher in retirement, possibly due to a generous pension plan, a large amount of registered investments or other income then TFSA contributions may be the be better way to go. However, if like most people, your income will be higher during your working years than in retirement then it is usually more beneficial to make RRSP contributions first, due to the immediate tax savings, before making TFSA contributions. To get the most out of your RRSP contributions we encourage you to contribute your tax refund to your RRSP also. For many clients we recommend doing both. We encourage you to consult with your accountant or tax professional, we can recommend one to you if needed.
While RRSPs are usually better for retirement savings, TFSA are better for shorter term savings. Both account types allow a broad range of investments inside them; and the tax on the capital gains, dividends and interest income generated doesn’t have to be paid each year.
There is no annual deadline for TFSA contributions, however for any withdrawals made the corresponding contribution room will not be restored until January 1st of the following year. The deadline for RRSP contributions allowed to be deducted from the previous year’s income is March 1st (February 29th during a leap year) or the next business day.