With RRSP season upon us, many investors are trying to decide whether they should be putting money into their RRSP. Over the past few weeks, several have asked me whether RRSP investments make sense or should they consider depositing money into a tax free savings account instead. There are a large number of investors today that don’t know the difference between the two, and this has caused some confusion.
The amount of contribution a person can make to an RRSP depends on that person’s income from the previous year, with 2014’s maximum set at $24,270. The amount an individual contributes to an RRSP can be deducted for income tax purposes. In my opinion, this is a huge benefit and one of just a few investments that government allows you to deduct from your income tax. When a person decides to withdraw money from their RRSP, the amount withdrawn gets added to that person’s income in the year the money is taken out as taxable income. All the growth on investments made inside the RRSP compound tax free.
Tax Free Savings Accounts (TFSA), in my opinion, have been labelled incorrectly. I would call this type of an account a Tax Free Investment Account not “savings account.” Many people have communicated to me over years that they were unaware they could invest their TFSA money. Thus, they have just kept their dollars sitting in cash while earning very little interest. I believe, depending on what you are investing for, individuals should be investing their Tax Free Account dollars into something that will earn more than just one or two per cent. Like RRSP’s, all growth inside Tax Free Savings Accounts is not taxable. Money is able to compound over time tax free.
However unlike RRSP’s, when an investor pulls money out of their TFSA, they do not have to pay any taxes at that time. Contributions into a TFSA are not tax deductible. There is a $5,500 per year limit for all eligible individuals and if you don’t use up that room each year, it can get carried forward to subsequent years. Thus today, with TFSA’s being introduced in 2009, investors can contribute up to $36,500 for the life of the plan.
Long Term / Immediate
I believe there are a few reasons to own one account over the other. I consider Tax Free Savings Accounts for more immediate money as well as long term money. If an investor requires the money they are investing within the next few years, then TFSAs make more sense. RRSPs are longer term investment vehicles to help individuals save for their retirement. They are not meant to be used as a source of cash on short notice. As well, if you are a person with a small tax bill each year, then RRSP’s may not make sense for you, as you will not need the tax break your RRSP contribution provides. Instead, you should consider the Tax Free Savings Account for your investment dollars. You can remove your money at any time without tax implications and money with still grow tax sheltered.
In an ideal situation, if an investor can do both, that would be the best scenario. Maximizing their RRSP contributions and Tax Free Savings Account contributions would be the best way to go. Now that the Tax Free Savings Account is in its seventh year, it has now, in my opinion, become a viable option for investor dollars as each person can now contribute up to $36,500 in total if they have not contributed before. A large enough amount to be worthwhile for many investors. I recommend each investor consult their Investment Advisor to see which type of account is better for your situation.