RSP or TFSA? How to choose

The keys to un­der­stand­ing the pop­u­lar sav­ings tools

Metro Canada (Toronto) - - SPECIAL REPORT: RETIREMENT SAVINGS PLANS - Michelle Wil­liams

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.

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