Should I Contribute to an RRSP or a TFSA?

by Pam on February 9, 2010






With the introduction of the Tax Free Savings Account (TFSA) in January 2009, Canadians now have another investment vehicle option to save for retirement.  Whereas before, most people took advantage of the immediate tax deduction for contributing into a Registered Retirement Savings Plan (RRSP), now they have to consider what will be most beneficial to them in the long run.   With the RRSP contribution deadline for 2009 fast approaching, it’s important for Canadians to make this decision ASAP.

What are the advantages of contributing to a TFSA?

Although you don’t receive an income tax deduction for contributing into a TFSA, there are some important advantages to consider.  All earnings within a TFSA are not taxable, whereas with an RRSP, earnings are tax deferred, but when funds are withdrawn, they are fully taxable.

A second advantage is that there are no expensive tax implications when you withdraw from a TFSA.  Since you’ve already paid tax on the money you contribute to a TFSA, when you withdraw the funds it is not a taxable event.  By contrast, if you withdraw from an RRSP, not only are you subject to an immediate withholding tax, you also have to add the amount withdrawn to your income for the year and you may end up paying more tax when it is time to fill out your tax forms or prepare your online taxes this year.

A third advantage to the TFSA is that you never lose your contribution room.  You can put up to $5000 into it each year and if you happen to need the funds during the course of the year, you can put that amount of money back into the TFSA any year thereafter.  Athough you are restricted from putting it back in the same year, at least you never lose the contribution space.  On the flip side, with an RRSP, when you withdraw the contribution room cannot be recovered.  It is lost forever.

A fourth and extremely important advantage to using a TFSA to supplement retirement income is that money in a TFSA will not impact the amount of Canada Pension (CPP) and Old Age Security (OAS) you will receive.  However,  when you withdraw from an RRSP, you need to add that amount to your income for the year and that can decrease the amount of CPP and OAS that you receive, so it’s not wise to have all your retirement savings with an RRSP.

The TFSA has several advantages, but the RRSP also offers the immediate benefit of the tax break.  It’s up to you and your accountant to do the number crunching to see just how much will be beneficial to contribute into an RRSP.  With the leftovers, I would highly recommend considering using the TFSA to supplement your retirement savings.  You might as well make use of this new savings vehicle that can help you build a solid strategy for your future.

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Karen March 1, 2011 at 8:26 pm

I’ve been looking at these lately as well… I’m actually considering them as a viable alternative to using RESPs to save for the kids’ future. With a TFSA, they won’t be penalized if they decide to use the money for something other than a college education (ie a wedding, a house downpayment, a car, a business start-up…)

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