So you’ve been budgeting wisely and you’re starting to see your savings account grow. Or maybe you’ve received money through an inheritance or work bonus. It’s time to look at your life goals and decide what to do with that nest egg. What is your next big purchase going to be? A car, a house, a renovation, a trip to Europe? Or are you saving up for the days when work is history and you can retire in style? Whether your goals are short or long-term, there are two popular investment options – a TFSA and an RRSP.
As a financial advisor, and an experienced mortgage broker with many clients I have helped achieve their financial goals in real estate; I am very familiar with both options and which one will help you best achieve your goals. This article will help clarify these savings choices and the benefits of each investment product so you can make an informed decision. Then, when you’re ready, give me a call, or set up an appointment with me online, and let’s design your game plan for that investment.
First, what’s a TFSA or RRSP?
TFSA stands for a tax-free savings account. And that’s the benefit of it… it’s tax-free! You can take money out at any time and the amount that your investment increases in value, you aren’t taxed until you take that money out of the account. You can save up to $6000 a year from the time you turn 18 and the amount accumulates each year. Removing money doesn’t affect your eligibility for some federal income benefits like Old Age Security, Guaranteed Income Supplements, the Canada Child Tax Credit or GST credit. To qualify though, you must be a Canadian resident, 18 years of age or older, and have your own Social Insurance Number. Whether you are saving for the short-term or long-term, having a TFSA could be a great option for you.
RRSP, on the other hand, stands for a registered retirement savings plan. And no, it doesn’t only have to be for retirement. The key benefit, however, is that it’s the most tax-efficient solution to fund your retirement. The Canada Revenue Agency sets out an annual maximum contribution amount based on a percentage of your income. Every dollar you put towards an RRSP (within your specified contribution limit) reduces your earned income for that year. That means when you contribute to your RRSP you get an annual tax deduction. If you’re in the higher tax bracket currently, investing in your RRSP is a smart way to reduce your taxes to an extent. The maximum contribution each year is 18% of your gross income. Another unique feature of an RRSP is that it can hold a multitude of investments such as stocks, mutual funds, GICs, bonds, etc. Over time, these locked-in investments will increase in value.
So, which one do you invest in? Ask yourself these 3 questions
What do you plan on doing with the money?
Choosing between a TFSA and an RRSP depends on what you’re saving up for. If you’re saving up for retirement… well it’s in the name! It’s also a good option if you’re saving to buy your first home because you can use the money, without penalty, for a down payment. You could also use your RRSP for larger payments and, because you get taxed when the money is withdrawn, you probably won’t spend the money as quickly. You will also save money through tax deductions and your RRSP can build up interest through investments which adds more cash to your account.
If you’re using the account just to save your money for a pair of Maple Leaf tickets or a trip to the Caribbean, then it would be more beneficial to use a TFSA instead. If you plan on investing money for your retirement over multiple years, you’re thinking of buying a home, or you want to reduce your taxable income, it makes more sense to have an RRSP.
How long are you planning on saving money?
If you’re planning on using your savings in the next year or two, it makes sense to invest in a TFSA so you don’t get penalized when you take the money out like you would with an RRSP. Plan to use an RRSP for longer financial goals, like retirement. There are significant penalties to pay if RRSPs are accessed before your age of retirement (with the exception of the Home Buyer’s Plan or the Lifelong Learning Plan).
If you’re saving for your dream vacation or a kitchen renovation, that’s a very different goal than saving for retirement over the next 35 years.
Will I make a profit in each account?
Both of these plans will allow your savings to grow tax-sheltered. A TFSA offers more flexibility and your withdrawals are always tax-free yet you won’t get a tax deduction. With an RRSP, you do get a tax deduction when you contribute and you pay taxes when you withdraw funds. You can also reduce your taxes by making a spousal contribution. The higher-income spouse can contribute to the lower-income spouse’s RRSP. The spouse who is contributing will get the tax deductions. These funds are investments so, if you manage them wisely, your account will grow and earn interest putting your hard-earned dollars to work for you.
Now for the hard part… which one do you choose?
Starting to save early for retirement is very wise. There are many worries in life and something in the future, such as retirement, may seem insignificant. Overall, both RRSPs and TFSAs are excellent ways to invest your money and watch it grow, and both offer many options when it comes to how and where you can invest. Knowing your long-term personal and financial goals is critical in choosing which one to start with. Ideally, it would be best to invest in both; having a TFSA as an emergency fund or for short-term goals, and having the security of an RRSP for your future retirement fund. You may want to start small with both…but most importantly, now is the time to get started.
There’s a lot of information out there on how to invest your money, and frankly, it can be overwhelming. My best advice is to be informed and organized. Do your research and talk to an experienced financial advisor, like myself, Darren Robinson. Whether you’re wondering about TFSAs, RRSPs, or simply how to start planning for the future, contact me by calling (705) 315-0516. I love helping my clients understand their options, explaining wealth strategies, and of course, talking about mortgages too.