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RRSP or TFSA: How do I make the right choice?

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Many of us have good intentions to save, but don’t always know which option is best for our situation. RRSP OR TFSA? Is it better to contribute to a Registered Retirement Savings Plan(RRSP) or a Tax Free Savings Account(TFSA)?

Yes, funds invested in an RRSP or TFSA grow tax-free while in the account. However, there are advantages and disadvantages to each of these options, which is why it is important to know the differences between them to make an informed decision.

DIFFÉRENCE : COTISATIONS ET RETRAITS

Assuming you have sufficient contribution room, the money you contribute to an RRSP is deducted from your income, saving you tax in the current year. The money you contribute to a TFSA is not deducted from your after-tax income.

However, amounts withdrawn from an RRSP are included in your income, while amounts withdrawn from a TFSA are not.

ÉCONOMIES D’IMPÔT : LEQUEL DE CES COMPTES EST LE PLUS AVANTAGEUX?

The answer depends on your marginal tax rate in the year of contribution versus your marginal tax rate in the year of withdrawal. If the rates for these years are equal, the two accounts are essentially equivalent in terms of tax savings, although because of the deduction, the RRSP will have more money growing tax-free. If your marginal tax rate in the year of contribution is higher, you’ll probably be better off contributing to an RRSP. If the rate in the year of the Contribution is lower, you may be better off contributing to a TFSA.

Example

This year you are in a 50% tax bracket. You contribute $2,000 to your RRSP, which saves you $1,000, so your net investment is $1,000 after tax.

You also contribute $1,000 to your TFSA. Since this amount is not deductible, your net investment is also $1,000 after tax.

Both amounts double in value in a future tax year. The value of the RRSP investment increases to $4,000 and the TFSA investment increases to $2,000. You remove both amounts and are still in a 50% tax bracket. The amount withdrawn from the RRSP is subject to a 50% tax, leaving you with a net amount of $2,000. However, the amount withdrawn from the TFSA is not included in your income, leaving you with a net amount of $2,000.

On the other hand, if your future tax rate is less than 50%, the net amount withdrawn from the RRSP will be more than $2,000. If your future tax rate is more than 50%, the net amount withdrawn from the RRSP will be less than $2,000.

ATTENTION : TAUX D’IMPÔT EFFECTIF ET DROITS DE COTISATION

Finally, it is important that you use your “effective” tax rate for the above purposes. For example, if your “basic” tax rate remains the same, but the amount withdrawn from the RRSP in the future year subjects you to the Old Age Security clawback rule, or reduces your age credit, your effective tax rate in the future year will be higher than the previous effective rate. In this case, investing in a TFSA would be more advantageous.

In addition, TFSA contribution room can be reused from year to year. If you withdraw funds from the TFSA, your contribution room is increased by an equivalent amount on the following January 1. With an RRSP, your contribution room built up each year is lost once you use it, and you need additional “earned income” in subsequent years to build up new room. Therefore, if you expect to have to withdraw funds from your plan periodically, a TFSA is preferable.

Would you like to be accompanied by an expert to see things more clearly? Do not hesitate to contact one of our tax professionals!

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