As most people know, the deadline to make an RRSP contribution that you can apply against your 2014 taxable income is March 1st, but you shouldn’t leave it until then to decide on this important savings strategy.
In fact, depending on your financial situation, an RRSP may not even be the best savings vehicle. Contributing to an RRSP reduces your taxable income, but when you withdraw that contribution it becomes taxable. The intention was to defer that withdrawal and associated tax until retirement when your income is expected to be lower. However, if, for example, you have a healthy pension plan your income in retirement will already be fairly high and the required withdrawals from your RRSP at that time will attract tax at a higher rate and possibly result in a clawback of your Old Age Security.
TFSA withdrawals are not considered income so they are not taxable, but they also don’t reduce your taxable income now when you invest in them; only the income earned on these investments is sheltered from tax. Amounts in TFSAs can be withdrawn at any time so they are better if you might have a short-term cash need.
There are two ways to use the money invested in your RRSP without actually withdrawing it: you can “borrow” from it to purchase your first home (Home Buyers Plan) or to attend a post-secondary institution (Lifelong Learning Plan). These two options add some flexibility to the RRSP route.
For most people RRSPs make the most sense. Take the tax refund you will likely receive and invest it in a TFSA for the most benefit. Neither investment vehicle is good for people who are short on self-discipline: if you withdraw from your RRSP you will be taxed on the amount; if you withdraw from your TFSA you may not be able to reinvest the amount until the next calendar year. Investing is for the long-term – leave it in there and let it grow!
Gwyneth James MBA CGA