In an ideal world, you would contribute the maximum amount to both your RRSP and TFSA every year. But if you had to make a choice, you may wonder whether it’s best to invest your savings in an RRSP, a TFSA or a combination of both.
In 2018, Canadians can contribute $5,500 annually to a TFSA. The TFSA limit is indexed to inflation and rounded to the closest $500. If you’ve never contributed to a TFSA, you currently have accumulated contribution room up to a maximum of $57,500—money that can grow tax-free and be withdrawn tax-free.
Below are examples that help illustrate the features of RRSPs and TFSAs and why one account may be more suitable under certain conditions.
Dr. Cruz, age 27, is a PGY1 resident, earning about $60,000. She’s eager to pay down her student debt but also to start saving money.
Because Dr. Cruz will likely earn much more later in her career, she might want to delay contributing to her RRSP until she is in a higher tax bracket. Instead, she could benefit from the flexibility offered by a TFSA and use the savings to, for example, make a down payment on a house. She could even accumulate funds in a TFSA to make an RRSP contribution at a later date. Alternatively, Dr. Cruz could contribute to her RRSP during her residency but defer the deduction until she is in a higher tax bracket.
Dr. Hoyano, age 38, is married with one child and her spouse stays at home. She wants to contribute money to a spousal plan for her husband.
Dr. Hoyano can contribute to her spouse’s RRSP and claim the deductions against her own income to the extent of her RRSP contribution room. This will also reduce the overall tax liability in retirement by levelling out the taxable income amounts.
Dr. McCurdy, age 45, has incorporated his medical practice and pays himself through dividends. He wonders if it’s worthwhile to draw money out to put in an RRSP or TFSA.
Because he’s only paying himself dividends, Dr. McCurdy does not create any room for RRSP contributions. He can, however, take full advantage of his TFSA contribution room. This will allow him to enjoy tax benefits by avoiding taxes on the investment earnings from funds held within his TFSA. Dr. McCurdy could draw dividends while making use of the corporation’s notional account balances, when available, such as the corporation’s Capital Dividend Account or Refundable Dividend Tax on Hand account.
Dr. Vendel, age 62, wants to continue contributing to his RRSP to benefit from the tax deduction. But he’s concerned that when he retires in a few years, his retirement income will place him in a high personal tax bracket.
Dr. Vendel could fund a TFSA as well as an RRSP. Although he would not get the tax deduction for the TFSA contributions, he would benefit in retirement from the fact that TFSA withdrawals are not subject to tax. He can structure his retirement income withdrawals from each plan to pay the least tax as possible and minimize the impact to his OAS benefits.