The TFSA / RRSP debate never goes away, but choosing between 2 may be easier than you think.
People in Canada happen to be the luckiest people on the planet to have the chance to build a successful strategy for setting aside money for a comfortable life in their old age. To be more specific (and less agitated) — we’re talking about two great options to get a tax credit and save money for the future – use tax-free accounts called TFSAs and RRSPs.
It may be tough at first to select the most advantageous choice for safeguarding your future savings. In an ideal world, you would like to include both accounts in your savings strategy, but in reality, maxing out both accounts can be difficult. Taking this into account, you could be faced with the need to choose an appropriate option for you.
Knowing the profits and drawbacks of these accounts will help determine the best solution for your financial needs.
A little about Tax-Free Savings Account (TFSA)
TFSA was launched to allow citizens of the city of Canada who have reached an age of maturity to set money aside without paying fees. Initial deposits into the savings option are subject to fees. The sum of contributions allоwed to the accоunt is not endless, as each year the governmentаl structures set the barrier for the highest sum allowed, this year the limit reached the sum of six thousand dollars.
Highlights:
- No deposit deadline; investments can be carried over to subsequent years.
- TFSA can be utilized as an investment vehicle: there is an option to hold stоcks, bоnds, EТFs
- No fees are required on your ventures and money.
A little about Registered Retirement Savings Plan (RRSP)
The RRSP is a type of investment account or savings plan into which you can put money to have a comfortable retirement. It was set in 1957. Your closest relatives, such as your spouse or common-law partner, are usually responsible for making deposits into the account. Typically, the account is opened at a large, well-known bank or wealth management firm. The RRSP account is only open to people under the age of 71, unlike the other savings vehicles that can be deposited at any time.
You should be aware that the sole benefit of an RRSP is that all of your investments are protected from fees. You will be charged fees as soon as you withdraw your money.
There are strict limits on how much you can set aside each year, with the government institutions setting the bar at the most feasible. In 2021, the cap will be eighteen percent of earned income and not much more than $27,830.
Highlights:
- Fees are not due unless you elect to withdraw a certain amount
- Donations can be deferred to the following years; the annual authorized amount will not be depleted
- Absolutely no special fees for your initial deposits
Now that we’ve covered the theory let’s look at some real-life examples
As we have shown, the accounts described above are excellent tools that, when used strategically, can lead to a pleasant retirement. The only challenge that appears to remain unanswered is determining which one will provide you with the greatest benefit. The greatest strategy to obtain a higher quality of living in retirement is to contribute to both accounts. In reality, though, generating enough money to fund both accounts properly can be difficult.
As a result, before picking between TFSAs and RRSPs, you should carefully analyze the benefits and drawbacks of both savings options. Here’s a quick guide to assist you in making your decision.
1. Take care of the Marginal income tax rate
You should invest in RRSP rather than TFSA if your current tax bracket is many times higher than what you will have for retirement after you leave your job. In such circumstances, your tax savings today will bе higher (because RRSP contributions are tax-free) than when you hit the amount you want to withdraw for retirement living with fees.
Let us say you have earnings of $87,000 (marginal tax rate of 43.40%) and save $9,000 per year. Let us say you plan to end your career and retire in 29 years with an annual income of $62,000 and a tax rate of 33.25%. In this specific situation, you should save to your RRSP to make an initial investment of $10,100.
On the contrary, if your marginal tax rate appears to be greater during retirement, TFSA is preferred to RRSP. This is simply explained by the fact that the taxes you will have to pay on the amount you withdraw from your Registered Retirement Savings Plan account will be higher than the taxes you can save now.
If we assume the situation where your current marginal tax rate is 33.25 percent, while your retirement tax rate would be slightly higher (43.40 percent), you should contribute the amount of $10,100 to the TFSA rather than the RRSP.
2. You have just started working
It appears sensible to favor TFSA if you have just begun working and earn a smаll amount annually. Your marginal tax rate is also low under the Canadian tax system if your annual income is low. Your funds will be taxed at a low rate in this situation.
For example, if your income in 2021 is $34,000, you would be in the 27.75% marginal tax band. You will save $1,387.50 if you decide to set it aside from your RRSP account.
3. Think about how much money you’ll have after you leave a job in old age
The OAS, CPP, voluntary pension plans and employer pensions make up the Canadian Retirement Income System. You have the right to apply for a variety of government benefits as a good Canadian citizen. You should be aware that if your net income in retirement exceeds the threshold established by government entities, you may face the possibility of having some of your pension payments canceled.
In retirement, the sum you remove from your RRSP is pooled with your other taxable income. The nuance is that if your net income in retirement exceeds 79,054 dollars, the government structures will deduct the required amount from your Old Age Security (OAS) in the amount of 15 cents for every dollar over the limit.
The Bottom Line
A word of advice, if you want to take advantage of most government incentives after you leave your job for life in retirement, note that your TFSA contribution does not count as taxable income.