Should I contribute to an RRSP or TFSA account?

We get asked the question a lot about whether or not to contribute to an RRSP or TFSA account and what we think is better.  The answer depends on your situation and can change each year.  Firstly you need to understand how each one works.

Tax-Free Savings Accounts (TSFA)

You do not receive an immediate tax benefit in the year you contribute, however, the growth of these investments is not taxable nor are the funds when you take them out of this account. 

You receive an allotted amount per year that can be contributed and if you do not use that amount it can be a contribution you make at a later date.

Any growth on the fund you put into the account does not reduce future room.

If you withdraw, the room will come back for future year contribution – just not in the same year.

What if you become a non-resident of Canada?  You can keep your TFSA in Canada but can no longer generate room for those years.

Your TFSA account does not affect any other benefits.

Just make sure you are not over contributing to your TFSA account as the excess amount you contribute to a TFSA is subject to a 1% per month penalty tax. So if you over contributed by $2,000 in a given year, you would be paying a penalty of $20 a month as long as the excess amount is still in your account. 

Registered Retirement Savings Plans (RRSP)

As opposed to the TFSA, you do receive an immediate tax benefit in the year you contribute however you will pay tax on the growth of these investments and they are taxable when you withdraw the funds. 

The amount of RRSP room you have is generally calculated based on 18% of earned income and this would be added to any unused room you have from previous years.  Just remember that this amount would be reduced by contributions made by you or an employer/union into an RSP or RPP.

Any contributions you make would offset the same amount of taxable income in that year – it Is important to note that if you owe $5000 in tax and decide to contribute $5000 in RRSP it will not reduce the full taxes payable, as the taxable income would not have been $5000.  Depending on your tax bracket, to eliminate that you may need to contribute more than double.

The deadline to contribute to your RRSPs would be the last day of February (of the following calendar year).

TFSA or RRSP which one should you choose to contribute to in a year?

In years your taxable income is low – you want to contribute to your TFSA and in years your taxable income is high, you want to contribute to your RRSP.  The reason for this is you want to take advantage of lower versus higher tax brackets so it makes sense.  Then you also want to use a similar strategy when withdrawing funds, you want to withdraw from an RRSP in years where you have lower income and from TFSA in years you have higher income.  Again, to take advantage of the rates of your income tax brackets.