The March 1 Registered Retirement Savings Plan (RRSP) deadline is looming—but is it the best savings vehicle for you?
An RRSP is a plan registered with the Canada Revenue Agency that holds investments. Contributions are tax-deductible, and the gains grow tax-free until you make withdrawals from the plan, at which point they are taxed at your income tax rate at the time of withdrawal.
You can contribute up to 18% of your earned income from the previous year, up to a maximum of $22,000. Adjustments may be made depending on any pension plans you have, and your carry-forward of unused RRSP contribution room since 1991.
For many years, RRSPs was the best savings program available to average Canadians. However, in 2008 the Canadian government announced Tax-Free Savings Accounts (TFSA). It’s a flexible savings plan that allows Canadians to contribute up to $5,000 a year to the account. Like RRSPs, unused room can be carried forward. Unlike RRSPs, contributions are not tax deductible.
The money within a TFSA grows tax-free, so if you invested the full $5,000 annually and your investment doubled, you could withdraw the $10,000 without paying tax on the full amount. Additionally, neither income earned within a TFSA nor withdrawals from it will affect eligibility for federal income-tested benefits and credits (such as the Canada Child Tax Benefit, the GST credit, the Age Credit, and Old Age Security and Guaranteed Income Supplement benefits).
Before deciding whether to invest in an RRSP or TFSA, speak with your financial advisor. As a general rule of thumb, if you’re in a high income bracket, an RRSP may be your best bet. If you’re in a lower tax bracket or want a savings vehicle with more flexibility, the TFSA is likely your best choice. Some Canadians are choosing to invest heavily in their RRSP (sometimes with the help of a generous employer matching program) and use their tax refund to invest in a TFSA.
Want to really get into the nitty gritty of which program is better before you seek expert advice? Check out www.taxtips.ca/calculator/tfsavsrrsp.htm and play with their TFSA vs RRSP calculator.
I know you’ve heard it before, but it’s advice worth repeating. Pay yourself first. If you wait every month to see how much money you can afford to save, you likely won’t contribute anything at all. Set up automatic bank withdrawals instead. This method also takes advantage of dollar-cost-averaging. Your contribution buys fewer shares when the price is high and more when the price is low. After a period of time, your average share price will probably be lower than if you had bought in with infrequent lump sum contributions.