Understanding RSPs and TFSAs (video)
Do you know the difference between RSPs and TFSAs? That's ok. You're not alone. Both TFSAs and RSPs can consist of savings accounts, GICs, stocks, or mutual funds. And they're both designed to help you save.
1. Boosting the Power of Saving
The 2 main things that impact your ability to save well are Inflation – which steadily reduces the real value of your savings over time, and Taxes – which reduce the amount you can save from your paycheque, and reduce return on your investments.
Both RSPs and TFSAs help you battle these forces. But they each do it differently.
Let's break it down…
2. RSP
So, what exactly is a Registered Retirement Savings Plan? (You'll see these called RRSPs and RSPs - both are essentially the same.)
As the name suggests, the Government created RSPs to encourage you to save for your retirement.
The money you hold in your RSP is tax-deferred – protected from income tax – until you withdraw it when you retire – at which point, your tax bracket will likely be lower, so the money will be taxed at a lower rate than when you earned it.
The amount you contribute to an RSP can be claimed to reduce your taxable income. For many people, that means a refund at tax time.
3. Why it makes sense to have an RSP
You get a tax deduction for your contributions, which can bring you a tax refund that you can then set aside as more savings.
Also,if you're a first-time homebuyer, you can withdraw up to $25,000 from your RSP as part of the Federal Government's Home Buyer's Plan.
4. TFSA
What exactly is a Tax-Free Savings Account?
It's a way of saving money for both long and short-term goals, without having to pay income tax on the growth.
You don't pay tax on money you withdraw from your TFSA either. That's what makes it “tax-free," and not “tax-deferred".
That means you'll be able to keep all of what you save.
5. Why it makes sense to have a TFSA
Unlike an RSP you pay no tax when you withdraw from a TFSA.
It's suited to both long or short-term goals, making it great for everything from emergency funds to long-term saving.
If you're in a lower tax bracket, RSP tax deductions may not be a priority for you, and you may prefer to save tax-free.
6. How do I Choose
So how do I know which one is right for me?
Here are some of the main considerations:
If you're in a high tax bracket now, and think you'll be in a lower tax bracket down the road, RSP contributions probably make more sense right now.If you're in a low tax bracket now, and think you'll be in a higher tax bracket down the road, consider a TFSA for now.
If you think your tax bracket now will remain steady down the road, your decision may be based more on whether you prefer an up-front refund on your whole contribution with an RSP, or the greater flexibility of a TFSA.
7. RSP and TFSA dos and don'ts
Here are a few general tips.
Don't be reluctant to start saving. Even small amounts add up over time.
Do save on a regular basis: stay committed. Automatic transfers can help.
Don't treat your TFSA or RSP like a regular savings account. Rules and tax implications impact when and how you should access this money.
Do know your money personality. Set realistic goals that will work with your spending style and habits.
Do save an emergency fund outside your RSP. RSPs are meant for long-term security, not for quick cash.
Now that wasn't so hard, was it?
For more detailed information on RSPs and TFSAs, download our guide.
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