It’s never too early to save for retirement. And it used to be very simple – open a Registered Retirement Savings Plan and saved as much as you can. Maybe if you’re a lucky high-earner with no debt or other liabilities, you are able to contribute to your retirement with investments beyond an RRSP. But, for the average earner, RRSPs are the way to go. Then in 2009 Tax Free Savings Accounts come along and now low and mid-level earners have options. Read on to find out the pros and cons of using RRSPs and TFSAs to save for your retirement.
We’ll start with the old classic. Basically, a saver will make contributions – which are deducted from their taxable income – to their RRSP and the money will appreciate tax-free while it sits there and waits for you to retire. Taxes on your investment are paid when you make a withdrawal from your savings. This can have several advantages:
- Depending on your current income and the income you have upon retirement, you could defer paying higher taxes on your contributions in favor of paying a taxes on your withdrawals at a lower rate when you retire. However, this presupposes your income at retirement will be less than it is now.
- Tax-upon-withdrawal often incentivized people to leave their RRSP investments alone until they need them in retirement.
The new kid on the block – TFSAs – are the opposite of an RRSP. Contributions are not deducted from your taxable income – meaning no tax refund. However, once you’ve paid the upfront income tax on your contributions, your money grows and can be withdrawn at any time, tax-free. This can provide some flexibility:
- This money is available to you at any time, which can be great in an emergency, but also may backfire as making withdrawals for short term needs or immediate needs detracts from retirement savings goals.
- Paying the income taxes now on your TFSA contributions also make sense in you plan to be in a higher tax bracket when you retire and begin to make withdrawals.
This is a simplified explanation of the main differences between using TFSAs or RRSPs – there are lots of other angles to consider your how your investments may affect Old Age Security clawbacks or your Canada Child Tax Benefit. The tax accounting experts at Liu & Associates will guide you through your retirement and tax planning options.