What is a TFSA?

A TFSA (or tax-free savings account) is a registered investment savings account that any Canadian resident 18 years of age or older can use for simple savings or to hold investments. It can store things such as exchange-traded funds (ETFs), guaranteed investment certificates (GICs), bonds, stocks, and cash.

Any income earned in the account, even when it is withdrawn, is tax free. This means that all interest, stock dividends and capital gains earned in your TFSA are not subject to income tax. However, your TFSA contributions will not lower your taxable income the way RRSP contributions will.

There is a limit to the amount you can contribute to your TFSA annually. However, you can transfer the unused premium margin to a current maximum amount for life. Each year you get an allocation of about $6,000 available for your TFSA, meaning you can put that amount away, plus any rollover from previous years (use this contribution margin calculator to find out how much room you have left).

So how is a TFSA tax-free? The money you put into this account is already taxed — you’re contributing to a TFSA of your net income — so there’s no tax credit at the time of deposit. But any gains you make in a TFSA — whether from a savings account, high-growth index fund, or other investment product — are not subject to capital gains tax, so you don’t owe any tax on your earnings when you make a withdrawal. In addition, any profits you earn on those investments will not affect your premium margin for the current year or years to come. Essentially, you pay no tax on the money you earn in your TFSA.

What is an RRSP?

A registered retirement savings plan, or RRSP, works similar to a TFSA in that it can hold savings and investments. A key benefit of this account is that you can contribute a large amount each year and your taxable income is reduced based on how much you contribute. In this way, an RRSP allows you to defer your taxes while saving for retirement. For 2021, the RRSP contribution limit is $27,830; for 2020 it was $27,230; and for 2019 it was $26,500.

An important thing to note is that you will pay tax on this money as soon as you withdraw it. When you turn 71, you can no longer contribute to your RRSP and must convert it into a Registered Pension Fund (RRIF) from which you can withdraw. This is when you start paying taxes on the money you have contributed. However, the idea is that because you retire, you fall into a lower tax bracket than you did during your high-earning years, so you’ve paid less tax overall because you invested in an RRSP.

TFSA vs RRSP: Which Is Better For You?

The best investment for you will depend on your individual financial situation and goals. Remember, with a TFSA you pay taxes on money you earned before you contribute, and with an RRSP you get tax refunds now on money you contribute, but you will have to pay taxes later when you withdraw money from the plan. This difference, along with your income, your investment timeline, and other factors, will all help you make the right decision for your investment dollars. You may be able to use both vehicles at the same time. So, is it better to maximize your TFSA or your RRSP? Read on for more information.

1. Income and tax bracket

Your income determines your tax bracket — the amount of income tax you have to pay — and these factors will greatly influence which investments work best for you.

This post TFSA vs RRSP: How to Decide Between the Two?

was original published at “https://www.moneysense.ca/save/investing/tfsa/tfsa-vs-rrsp-decision/”