RRSP vs TFSA: find the right balance
Most Canadians can benefit from having a Registered Retirement Savings Plan (RRSP or RSP for short) and a Tax Free Savings Account (TFSA) — both are great tax-sheltered savings vehicles.
The key difference is whether you pay taxes now or later. RSP contributions are tax deductible, so they generate a tax credit. But withdrawals are taxed as income.
TFSA contributions are made with after-tax dollars, so withdrawals are not subject to taxation. This makes TFSAs ideal for an emergency fund, as well as for saving for a vacation or other big ticket item.
Your circumstances and goals will determine how you allocate your resources. As you formulate your strategy for your RSP and TFSA, here are three scenarios to consider:
You believe your tax bracket in retirement will be lower than it is currently.
RSP contributions give you a tax break now, and your withdrawals in retirement may be taxed at a lower rate.
You have a generous pension plan, or for other reasons expect to enjoy a comfortable retirement lifestyle.
TFSA contributions will provide tax-free income in retirement. By comparison, withdrawals from an RSP (and from a Registered Retirement Income Fund) are taxable and, combined with other income sources, could push your taxable income high enough to trigger a clawback of your Old Age Security pension.
You're in a low tax bracket, but expect to earn more in the future.
If you direct savings to a TFSA now, you can save your RSP contribution room to use later, when you're in a higher tax bracket and your contributions may generate a larger tax refund.
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