Money & Career
Plan for retirement with a TFSA or an RRSP
Money & Career
Plan for retirement with a TFSA or an RRSP
For years, the only official retirement savings vehicle available to Canadians was a registered retirement savings plan, or RRSP. But on January 1, 2009, we got another place to put our hard-earned cash while saving on taxes: a tax-free savings account (TFSA).
Since then, many advisers and investment experts have debated over which of the two is a better savings account for retirement. The answer, of course, really depends on your situation. Here are five questions to ask yourself before investing your money.
1. Do you need the tax advantage?
TFSAs and RRSPs allow people to grow their savings tax-free. With RRSPs, though, when you deposit money you get a tax break. This is most advantageous to people who are in the highest tax bracket: they'll get the biggest cheque back from the government. Many people use that extra cash to fund their child's RESP or pay off debt. For modest income earners who won't get much of a tax break, though, the RRSP makes a lot less sense. If you earn less than $30,000 a year, use a TFSA.
2. How much will you have when you retire?
If you think you'll have a lot of money saved up when you retire, consider using a TFSA. The money in an RRSP is taxed when you withdraw. The idea is to invest in a RRSP when you're making a lot of money, and getting a big break on income tax, then remove the cash in retirement, when your income is lower and you pay less tax on the same amount of money.
But these days, people are working longer or often have so much saved up that they'll still be in a high tax bracket in retirement. If your tax hit will be as much as or higher than your tax break, an RRSP may not be the best option.
3. How old are you?
If you're closer to retirement, a TFSA won't be a viable option for most of your assets. That's because contribution room in a TFSA only grows by $5,000 a year. You can catch up on that amount -- if you haven't put any money in your TFSA yet, you can put in a total of $5,000 per year starting with 2009 -- but if you've been putting $5,000 in every year, you can only save another $5,000 this year.
Many people want to save more than that. TFSA room starts expanding as soon as someone hits 18. So younger people, even if they wait 10 years to start investing, will have a lot more room to play with than today's soon-to-be retirees.
4. Do you own a business?
Many incorporated business owners pay less tax by keeping their money in their company. That means their actual income for tax purposes is low. Entrepreneurs also have the option of saving in an Individual Pension Plan (IPP) -- it's like an RRSP, but for business owners.
If you use an IPP and withdraw little from the business, then it makes sense to use a TFSA. Again, low-income earners don't get much back from the government when they invest in an RRSP -- after all, they only give back what you've already given to them.
5. Will you need the money sooner?
It's never a good idea to remove your savings before retirement, but if you think you might need the cash, it's generally better to use a TFSA so you don't have to pay tax when you withdraw. If you know you won't touch your money, then an RRSP should still be considered.
For most of us, it makes good sense to max out the TFSA first, then consider the value of an RRSP based on income. The only real way to solve the question for good, though? Use both.
Since then, many advisers and investment experts have debated over which of the two is a better savings account for retirement. The answer, of course, really depends on your situation. Here are five questions to ask yourself before investing your money.
1. Do you need the tax advantage?
TFSAs and RRSPs allow people to grow their savings tax-free. With RRSPs, though, when you deposit money you get a tax break. This is most advantageous to people who are in the highest tax bracket: they'll get the biggest cheque back from the government. Many people use that extra cash to fund their child's RESP or pay off debt. For modest income earners who won't get much of a tax break, though, the RRSP makes a lot less sense. If you earn less than $30,000 a year, use a TFSA.
2. How much will you have when you retire?
If you think you'll have a lot of money saved up when you retire, consider using a TFSA. The money in an RRSP is taxed when you withdraw. The idea is to invest in a RRSP when you're making a lot of money, and getting a big break on income tax, then remove the cash in retirement, when your income is lower and you pay less tax on the same amount of money.
But these days, people are working longer or often have so much saved up that they'll still be in a high tax bracket in retirement. If your tax hit will be as much as or higher than your tax break, an RRSP may not be the best option.
3. How old are you?
If you're closer to retirement, a TFSA won't be a viable option for most of your assets. That's because contribution room in a TFSA only grows by $5,000 a year. You can catch up on that amount -- if you haven't put any money in your TFSA yet, you can put in a total of $5,000 per year starting with 2009 -- but if you've been putting $5,000 in every year, you can only save another $5,000 this year.
Many people want to save more than that. TFSA room starts expanding as soon as someone hits 18. So younger people, even if they wait 10 years to start investing, will have a lot more room to play with than today's soon-to-be retirees.
4. Do you own a business?
Many incorporated business owners pay less tax by keeping their money in their company. That means their actual income for tax purposes is low. Entrepreneurs also have the option of saving in an Individual Pension Plan (IPP) -- it's like an RRSP, but for business owners.
If you use an IPP and withdraw little from the business, then it makes sense to use a TFSA. Again, low-income earners don't get much back from the government when they invest in an RRSP -- after all, they only give back what you've already given to them.
5. Will you need the money sooner?
It's never a good idea to remove your savings before retirement, but if you think you might need the cash, it's generally better to use a TFSA so you don't have to pay tax when you withdraw. If you know you won't touch your money, then an RRSP should still be considered.
For most of us, it makes good sense to max out the TFSA first, then consider the value of an RRSP based on income. The only real way to solve the question for good, though? Use both.
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