One of the most common questions we get from clients is whether they should invest in a TFSA or an RRSP. They both have their advantages but depending on your situation, one might be better than the other. The RRSP offers greater tax benefits under the right circumstances but the fact that you have to pay income taxes when you take out money from it makes it less flexible. The TFSA may not provide as many tax benefits as the RRSP when used under the right circumstances, but since taking money out of it has no tax consequences, it's much more flexible.
When should you use an RRSP?
RRSP contributions are tax-deductible but RRSP withdrawals are taxed like income. Very important: to use the RRSP properly, you need to make sure that your tax bracket is high when you're contributing to it but that your tax bracket is low when you withdraw from it.
You should invest in an RRSP if:
- You're investing for retirement, are making more than $50,000 a year and don't expect your income to grow significantly.
- You're planning to use your RRSP for a Home Buyer's Plan.
- You're planning to use your RRSP for a Lifelong Learning Plan
When should you use a TFSA?
The TFSA is a simpler tool that allows your investments to grow tax-free but doesn't provide the tax-deduction benefits of the RRSP. It's ideal for objectives that are earlier than retirement but can also be used for retirement in certain cases.
You should invest in a TFSA if:
- You're investing towards an objective that is sooner than retirement (a home, wedding, vacation, car, etc).
- You're investing for retirement and are making less than $50,000.
- You're investing for retirement, are making more than $50,000, but expect your salary to go up significantly. Using a TFSA in this case allows you to use your RRSP contribution room later, when you're at a higher tax bracket, to take advantage of a greater tax deduction.
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