If you are Canadian and planning for retirement, there are many unique terms you need to be familiar with. Two of the most important ones being RRSP and TFSA.
But more than that, you need to know what’s the advantages and disadvantages of going for RRSP vs. TFSA. And vice versa. Read on to learn more about the pros and cons of each and how to choose between them.
RRSP vs. TFSA
RRSP stands for a registered retirement savings plan. RRSPs are tax-deferred accounts. This means that you pay into RRSPs with pre-tax dollars.
Once you retire and start withdrawing money from your RRSPs, you pay your taxes then.
TFSA stands for a tax-free savings account, and is a way for you to invest post-tax dollars into investments that then can be withdrawn without any penalties whenever you want!
Because you are investing after-tax dollars into TFSAs, you can take it out anytime you want, tax-free.
When you claim your RRSP contribution at tax time, you might end up with a tax refund (depending on your tax situation). If you use that amount to top up your investment, you end up with an addition to your investment.
The biggest pros of RRSP vs. TFSA is that RRSPs have a bigger allowance right now, the maximum being 18% of your previous year’s income (up to $27,830 for 2021). That can really add up over the years.
Unfortunately, the maximum you can contribute to TFSAs is $75,500 as of 2021 (the Canadian government increases the allowance by a small amount every year). As you can see, the difference is quite huge between the two.
The major con of RRSPs is that you CANNOT take out money from an RRSP without penalties unless you use it to buy a home or for further education using the HBP (home-buyer plan) or LLP plan (life-long learning plan).
As said earlier, you can take out money from a TFSA anytime you want, without any penalties. But that doesn’t mean that you should. In fact, the best thing for you is to leave money in your TFSA to grow indefinitely.
This way, you can take advantage of the magic of compound interest.
Remember that you have to convert an RRSP into an RRIF by December 31st of the year you turn 71. But this rule doesn’t apply to TFSA.
Contribution Deadline Differences
For RRSPs, your contribution deadline would be March 1st for the previous year’s contributions. So Mar 1st, 2021 would be the deadline for the 2020 tax year.
Same as with TFSAs, you can carry forward your contribution room indefinitely.
Your TFSA contribution deadline would be December 31st, but since unused contributions are carried over, there is truly no deadline.
A Retirement Account in Canada Has 3 Choices
If you are wondering about how to choose between RRSP vs. TFSA, there are three choices available to you. You can either go for an RRSP or TFSA. Or if you have the funds available, you could go for both!
As you can see, both have their pros and cons and are suitable for a retirement account in Canada. The main thing to remember is you need to invest for retirement, and the account itself doesn’t matter that much.
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