Although the government provides innumerable savings plans to encourage savings amongst its citizens, the sheer number of options can prove to be confusing. In regards to retirement, taxpayers are commonly uncertain on whether Tax Free Savings Accounts (TFSAs) or Registered Retirement Savings Plans (RRSPs) are the better route to go.
While both the accounts are equally advantageous for saving purposes (Read: Tax-Free Savings Accounts (TFSAs) – What are the advantages?) there is a thin line between the two, making one more preferential over the other from an individual’s perspective.
The analysts at AG Tax have summarized a few points to assist an individual to decide between the TFSA and RRSP based on what benefits their personal savings and tax savings objective.
Retirement Savings: TFSAs & RRSPs
Tax-Free Savings Account (TFSA)
Individuals, aged 18 and above, can contribute after-tax dollars up to a certain limit ($5,500 for 2014, any additional contribution would be subject to penalties) into a TFSA, and he/she would not be liable to pay any taxes on any withdrawals made, income earned, or capital gains accrued through the sale of the asset. Additionally, it does not affect federal credits/deductions that an individual can claim.
Registered Retirement Savings Plan (RRSP)
An RRSP on the other hand, is a qualified retirement plan in which an individual or their spouse/common-law partner can contribute pre-tax dollars up to a certain limit ($24,270 for 2014) until they are 71 years of age. Thereafter, the RRSP needs to be converted to a Registered Retirement Income Fund (RRIF) in order to receive regular income from the account, which is subject to annual income taxes at a rate depending on the taxable income of the taxpayer for the particular year.
What Should a Taxpayer Consider Before Establishing Any of These Accounts?
Age Factor: Age plays an important role in choosing between a TFSA and RRSP; individuals who have just started working and have a long way to retirement may prefer concentrating their savings towards a tax-free account such as a TFSA which could provide for any other financial need (purchases, debt), rather than an RRSP, whose main and only objective is to build-up an individual’s retirement fund.
Priority of Financial Goals & Retirement: A lot depends on the priority of goals as well, if an individual would like to live a lavish lifestyle during retirement he/she would need to begin saving early or more amount towards retirement. However, if an individual has other financial objectives, such as: to travel, purchase a house/car or provide for wedding expenses, a TFSA makes more sense since the individual will need to withdraw from the account only for the expense and not for any taxes that would accrue in the case of a withdrawal from an RRSP or other type of account.
Income Tax Rate: Another factor that one should take into consideration is the income tax rate that an individual is subject to. If the individual’s income is liable to taxation at a lower income tax rate, then a TFSA would be a better saving option. An RRSP can be used as an investment vehicle in the later years when the individual’s income is higher and he/she would need such pre-tax saving options which could help reduce their taxable income. Additionally, the individual can contribute more dollars in an RRSP in the future years as catch-up to compensate for the years in which no contributions were made, thus helping to further reduce the taxpayer’s taxable income.
During retirement, taxpayers are usually subject to lower tax rates as the income is expected to be lower than when they were working.
Enthusiastic Spenders: An individual should also be aware of their spending behavior. The ease with which one can withdraw from the TFSA makes it an asset subject to quicker depletion in the case of enthusiastic spenders, and thus not fulfilling one’s saving goals. Therefore, in such cases, RRSPs could serve as a better retirement savings vehicle since there are certain legal formalities and withholding taxes involved in withdrawing from an RRSP. In fact, RRSPs allow withdrawal before retirement only through two acceptable ways: Home Buyers’ Plan (to purchase a residence for the first time), and Lifelong Learning Plan (to provide for full-time education plan).
Age Factors for Account Types
–If a Taxpayer is in their 20s or early 30s
For a young person, who has many years away from retirement, a TFSA may serve as a better investment vehicle since it could provide tax-free dollars for any future predictable/unpredictable expenses and, if unused, the asset could grow tax-free to be used to fund retirement with few or no tax hassles and worries.
Additionally, since young working taxpayers are more likely to be subject to lower income tax rates, they would not need to work on reducing their taxable income as would be the case in the future years when they could be subject to mid or upper level tax rates.
–If a Taxpayer is in their mid-30s or early 40s
In the later years, saving into an RRSP or increasing contributions towards an RRSP could be more helpful in building assets strictly for retirement. With the added advantage of making catch-up contributions for the earlier missed years, it could help reduce an individual’s taxable income quite significantly. Additionally, an RRSP could be beneficial in reducing the taxable income during that period since the contributions are made from pre-tax dollars.
Please note that there are significant filing requirements and potential penalties for U.S. persons holding Canadian Tax Free Savings Accounts. Please consult with a qualified cross-border tax advisor before opening a TFSA if you have an U.S. ties. See this article (Tax obligations for foreign nationals residing in the U.S.) here for more information.
A savings plan that works for a particular person may not be the best option for another person. As such, it is highly recommended to consult a tax practitioner regarding the best savings route to help save for an individual’s retirement, or any other financial goal, along with reducing the tax burden.
AG Tax LLP Can Help
If you have any tax-related queries or need assistance with tax planning or filing please contact AG Tax. Our tax professionals are highly-experienced with U.S. and Canadian tax laws and can provide you the right guidance to handle your tax situation.
Aylett Grant Tax LLP is a full service accounting firm with a dedicated team of experts, who are highly-qualified and experienced in handling situations related to U.S., Canadian, and other international tax laws.
We can assist with:
- Canadian Personal and Corporate tax returns
- Cross Border Taxation and Business Planning
- U.S. Personal and Corporate Taxation
- Disclosure of Foreign Assets and other information filings
- Retirement planning
- Estate Planning, Inheritance tax advice
To obtain a quote or to arrange for a consultation to discuss your tax related queries, please contact us at:
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