We all know that we should put money away for our retirement. The message has hit home and fortunately many of us are putting away at least 10 per cent — if not more — of our net income for our senior years. While this is undoubtedly a good thing, there still exists some confusion or lack of understanding about these savings vehicles.
The old standby — registered retirement savings plans (RRSPs) — have been Canadians’ go-to investment strategy for both new investors and seasoned savers. The tax-free savings account (TFSA) was introduced to Canadians in 2009 as an alternative way to save money.
Offering an alternative to the more established RRSP, the TFSA is a vehicle that allows Canadians to save and invest, with the income earned remaining free of taxes. Unlike RRSP funds, money removed from a TFSA at any time is not taxed.
While it may seem like both savings methods offer similar options, viewing both under an “apples to apples” comparison is not valid, as there there are significant differences between the RRSP and TFSA.
Here is a more in-depth look at both saving options.
Tax-Free Savings Account (TFSA)
Generally speaking, the TFSA is more flexible than your average RRSP. The tax-free savings account’s main benefit is that it allows you to access money at any time before retirement without penalty.
TFSAs also allow you additional room to invest if you’ve maxed out your RRSP contributions for the year. Unlike RRSPs, if you dip into your TFSA, you won’t lose contribution room for saving in future years.
One thing that you should consider regarding this type of account is that current and future projected income is a key variable in determining whether or not saving with a TFSA is worthwhile. For those who are above-average and middle-income earners now, and who have an eye towards a comfortable, middle-class retirement, an RRSP is the clear winner, all taxes and interest returns considered.
For those who are planning for a very affluent retirement, the TFSA is the best choice when the OAS claw-back is taken into consideration. If your income is below the societal average and you plan on maintaining the same level of living expenses during retirement, the GIS claw-back makes investment in an RRSP a much less profitable choice than an investment in a TFSA.
Like any other investment, it literally pays to do the math and calculate what will work best with your particular financial situation, both in the present and in the future.
Registered Retirement Savings Plans (RRSPs)
Introduced to Canadians in 1957 as a support to Canadians for saving towards retirement, registered retirement savings plans, or RRSPs, are one of the most used financial vehicles in the country. As noted in the Income Tax Act, approved RRSP assets can include a variety of financial products including savings accounts, mutual funds mortgage loans, income trusts, shares an labour-sponsored funds.
Any money that is contributed to RRSPs is deducted from taxable income for the payable year in which the funds were contributed. In addition, income earned from the account isn’t taxed. For these reasons, RRSPs are a popular choice for smart investors.
While RRSPs are a safe and proven way of making money on your savings, there are other considerations when deciding to let your money sit in an RRSP account. If by any chance you find yourself in a financial bind and need quick access to your funds, you’ll have to pay a penalty.
A withholding tax is automatically added to any RRSP withdrawals that are made before the funds mature. Depending on your tax bracket, this could mean anywhere between 10 an 30 per cent — enough to make you reconsider taking the money out, in some circumstances.
So, what’s best for you? Like any decision, it really depends on your personal set of circumstances as well as a number of other factors. To make sure that you get the most value from your savings, start with the numbers. Sit down with your partner, financial advisor or bank representative and get all of the facts.
At the end of the day, it’s your money and how you choose to make it grow should reflect both your comfort level and the sound, solid advice from a financial advisor you trust.
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