RRSP vs TFSA

Which one Best suits your needs?

It's that time of the year when the banks are touting their RRSP promotions to the customers to contribute their money into their RRSP before the February 29th deadline to be able to deduct it for the 2011 income tax return.

Also in the picture is the Tax Free Savings Account (TFSA). There are certainly no deadlines and no immediate tax break but there is potential for tax savings in the future. So how does RRSP and TFSA compare?

RRSP is made with before-tax earnings and is best used when the taxpayer is in the higher tax bracket to take advantage of tax deduction. Withdrawing the money in a lower tax bracket when the taxpayer retires allowing for lower taxes to be paid on the RRSP. The amount of contribution room is calculated at 18% of the earned income in the previous year less any pension adjustment (common for those who may have a defined benefit plan) up to a maximum of $22,970 (for 2012). For those in the lowest tax bracket, there is no real benefit to claiming the deduction in which case, a TFSA may be better for them. In addition, RRSP would be included in income used for calculation of OAS and other benefits.

The TFSA is available to all Canadians 18 years and older and will be set at $5000 a year and indexed. This means that the taxpayer, regardless of their income can contribute up to $5000 a year into the TFSA. It can hold a regular savings account, investments, GIC's, etc. Any income that is earned on the contributions is tax-free. This is ideal for those who are in the low income tax bracket and would likely not move up into the higher tax bracket. In addition, TFSA is not included in income for OAS Clawback and other benefits. Furthermore, if one contributes the full $5000 and withdraws money out, they may not re-contribute until the following year. This account can be used as an emergency fund, pension supplement, vacation fund, etc.

For some lucky people, they may be able to max out their contributions to both the RRSP and the TFSA but some planning is required to ensure minimizing the taxes in the future.

RRSP is tax-deferred meaning you pay taxes later while money in TFSA is tax-free. Generally, if one expects to be in a higher tax bracket in retirement, the RRSP may not be suitable for that person. If one will always be in the lowest tax bracket, the TFSA may be the better choice. However, there are other factors to consider such as first-time homebuyers, lifestyle changes, retirement plans, etc. It is best to speak to an accounting professional to discuss this further to minimize the taxes in the future. Contact the accounting professionals at VS Group for more information.