RRSP, TFSA or both? What you need to know

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There’s no one-size-fits-all answer to the question of whether it’s better for a physician to put money into a registered retirement savings plan (RRSP) or a tax-free savings account (TFSA): both options can boost savings and help lower the amount of tax to be paid.

Whether you contribute to one or the other, or both, you can maximize their benefits by using RRSPs and TFSAs in strategic ways, which may change at each stage of your life and your practice.

RRSPs and TFSAs: A few things in common

An RRSP and a TFSA are both investment accounts, registered with the Canada Revenue Agency (CRA), that offer extra tax benefits as an incentive for Canadians to save more money.

You can save a generous amount. Both accounts allow you to contribute up to a maximum amount for each tax year.

  • For a TFSA, that is universally set at $6,000 in 2020. However, your “contribution room” has been accumulating since 2009 (for every year that you were 18 or older). If you have never contributed, you can now put in $69,500.
  • The RRSP contribution room is set individually, determined by your earned income and other factors. In general, for 2020, it’s 18% of the previous year’s earned income to a maximum of $27,230. Look for your RRSP contribution limit on your most recent Notice of Assessment from the CRA.

You can top up anytime. You can always “catch up” later, when you’re earning more. If you don’t contribute to an RRSP or TFSA this year, you can carry over unused contribution room to future years.

You can invest these funds however you like. Both types of accounts allow you to invest your savings in a portfolio of qualified investments such as stocks, mutual funds and term deposits. Some types of investments, however, are not well suited for RRSP or TFSA funds — you may wish to get guidance from a financial advisor before investing.

You can reduce your taxes. Both of these savings vehicles offer tax incentives, but in very different ways. The key difference is in how each treats contributions and withdrawals.

RRSPs: Save now, but pay income tax later

While the RRSP was introduced as a retirement savings account, its tax advantages can be useful during any period of lower income in a doctor’s career, such as a parental leave or time taken off to volunteer.

There’s a tax deduction on contributions. The amount you contribute can be deducted from your earned income (up to your maximum contribution room) for income tax purposes. This may even result in a tax refund for you.

Investments are tax sheltered until you withdraw. So long as your savings are left inside an RRSP account, investments can grow tax free. RRSP withdrawals are treated the same as other pre-tax income, however, and are fully taxable. So, you’ll eventually pay taxes, but the idea is to hold off withdrawals until retirement, when you’ll likely be in a lower tax bracket than you were through most of your career.

You can dip in for a down payment or studies. You can still access limited amounts, tax free, in an RRSP for certain uses, provided the money is repaid over time. The federal government allows withdrawal of up to $35,000 for a down payment on a home, through the federal Home Buyers’ Plan, or up to $20,000 to finance full-time training for yourself or your spouse, through the Lifelong Learning Plan.

TFSAs: Investments can grow, tax free

A TFSA can be used to save for anything at all, long or short term. You might be planning a family trip, thinking ahead to a sabbatical year, or just wanting funds to do fun things: in any case, this savings vehicle can help you save money faster and more efficiently.

You keep everything your investments earn. You can’t use a TFSA to reduce income tax, since you fund it with after-tax dollars. But once you’ve contributed to your account, you get to keep every dollar earned. There’s no tax on interest income or any capital gains to be paid, ever.

There’s no tax on withdrawals. You can take money out anytime, and there’s no tax or penalties on withdrawals. Money from your TFSA does not count as income, and does not trigger any taxation. Also, these withdrawals from your TFSA don’t affect how much Old Age Security, Guaranteed Income Supplement or Employment Insurance you receive.

You can re-contribute after withdrawing. If you withdraw funds from your TFSA, you’re allowed to re-contribute that amount in the future — the amount withdrawn will be added back into your contribution room the following calendar year.

A smart tax strategy: Allowing you to save at the right time

Whether you save and invest with an RRSP, TFSA or both, you’ll benefit from the power of compounding. The money earns a return, and your money grows faster when it earns a return on the return. MD Financial Management’s compound growth calculator can show you how.

Both types of registered savings accounts can be used to boost the effectiveness of your financial planning over time. The optimum amount to contribute to your RRSP or TFSA, or both, each year may shift as your family grows or your practice changes. If you’re not in a financial position to contribute to both, you may wonder what your best course of action would be at this point.

Build your TFSA now and boost your RRSP later. If you’re in the early stages of your residency, for instance, you could focus on saving money in a TFSA since your salary is lower than it would be in the future. Once you start earning a lot more, you can contribute the maximum allowable amount to your RRSP where you’ll benefit by being in a higher tax bracket.

Use any tax refund to pay debt, boost savings. If you do contribute to an RRSP, think about using any tax refund you might receive to pay down debt or add to your TFSA investments — to spread the tax benefits into the future!

Plan ahead to reduce taxes

Whether you invest in an RRSP, TFSA or both, there’s no need to feel pressured to max out your allowable contributions all at once. What’s more important is to plan ahead, and to have a strategy to reduce taxes and build resources throughout all stages of your career.

MD Financial can help you to effectively apply your RRSP and/or TFSA contributions over time to minimize taxes and achieve your financial goals, such as starting a medical practice, taking time for a sabbatical or saving for retirement.

An MD Advisor* can review your financial plan, or work with you to create one, and recommend ways to ensure you don’t pay more tax than necessary — now or later.

* MD Advisor refers to an MD Management Limited Financial Consultant or Investment Advisor (in Quebec), or an MD Private Investment Counsel Portfolio Manager.

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