RSP or TFSA? How to choose
The keys to understanding the popular savings tools
Two of the most popular savings tools available to Canadians are the RSP (Retirement Savings Plan) and the TFSA (tax-free savings account). But how do you decide which option is best for you? First of all, it’s important to understand the differences between them: “They’re both tax- advantaged savings plans that are endorsed by the federal government, but with some real differences,” says Kurt Rosentreter, a senior financial advisor at Manulife Securities and a chartered accountant in Toronto.
The RSP, around since 1957, was once the go- to savings plan for any Canadian looking to save for retirement. How much you can put into your RSP annually is directly related to your earned income: you can contribute up to 18 per cent of your previous year’s earned income each year, which gets deducted from your taxable income at tax time. Whatever you don’t use gets carried over to the following year.
“So there’s room to build significant savings for retirement,” says Phil Goldband, partner at G&G Partnership in Toronto.
Though you’re taxed when you withdraw your RSP savings, presumably this won’t be until you’re retired and your income and tax bracket are lower. As such, you’re pay- ing significantly less tax on the money when you take it out than you would have paid when you made the contribution in your higher- income years.
In 2009, the federal government introduced the TFSA.
“There is no tax deduction for your TFSA contribution like there is with an RSP contribution,” explains Goldband, “however, when the money is withdrawn, the income earned comes out tax-free.”
Unlike with an RSP, the amount you can contribute to your TFSA is not related to income. Everyone is allowed to contribute the same amount: up to $5,500 for 2016. So how do you choose which of the two plans makes the most sense for your hard- earned savings?
“First, a lot depends on your income,” says Rosentreter. “The Canadian income tax system is progressive — the more you make, the higher percentage of tax you pay. The RSP offers a tax deduction for your contribution amount every year. So the higher your income, the more beneficial it is.”
For lower-income earners, the RSP tax deduction isn’t worth as much, since you’re not paying a high percentage of tax in the first place.
“Those with lower incomes may not be getting the bang for your buck with the RSP, so the TFSA contribution can make more sense,” adds Rosentreter.
But it’s not just about income level.
“Generally, it makes sense for young investors to put their money into TFSAs versus RSPs,” Goldband says, since they can withdraw the money any time they want without being taxed on the income earned.
For expenses like a new car, a home, tuition or a medical emergency, the flexibility of a TFSA comes in handy.
However, both savings tools are designed to serve the same goal: saving for retirement. To that end, the choice doesn’t have to be between one and the other. Young and old investors alike would be wise to look at both plans and consider the advantages each one offers.
“If someone has ample cash flow, they may want to consider maximizing both the RSP and TFSA contributions each year,” suggests Rosentreter.
Both RSPs and TFSAs have their advantages. Your choice will depend on your income and financial goals.