RRSP or TFSA? That's the burning question that many tax-paying Canadians ask themselves at this time of year when trying to decide what to do with any extra cash on hand. Which is right for you? It will depend on your personal situation and objectives.
If you are concerned about owing additional tax to the CRA or MRQ when filing your 2020 taxes, RRSPs are an excellent tool to minimize income taxes in the short run, and possibly in the long run as well. That's because contributions to a RRSP are deducted from your income, reducing your taxable income and therefore your tax payable. Reducing your taxable income may also have additional advantages. For one, since Canada has a progressive tax system, a reduction in income may place you in a lower tax bracket, thereby reducing your marginal tax rate. A lower income may also permit you to qualify for other income-tested benefits, like the GST Credit and in Quebec, the Solidarity Tax Credit.
This assumes, of course, that you have the RRSP room to make a contribution. You will also have to make that contribution within the first sixty days of 2021 to be able to apply it to your 2020 return. For 2020, your contribution is limited to 18% of your 2019 eligible earned income, to a maximum of $27,230, plus any unused contribution room from prior years that you may have. Pension plan contributions will also reduce this room. To make things easier, your 2019 Notice of Assessment will contain this information.
The TFSA limit isn't nearly as complicated. The amount you can contribute is the same for all Canadians 18 years of age or older - $6,000 in 2021, plus any unused contribution room from previous years. Another important feature is that your limit, once used, is not gone forever. Any withdrawals made are added back to your contribution room in the year following the year in which the withdrawal is made. You also generally won't get taxed on any investment gains or withdrawals made from a TFSA.
That's not the case for an RRSP. Once your contribution room is used, it's gone forever. Any RRSP withdrawals you make will not replenish it. That means it should be used wisely. If you think you may need to access your money in the short-term, a TFSA may be a better choice.
You won't get a tax deduction for a TFSA contribution though, so if your goal is to minimize your 2020 tax bill, the RRSP may be the more attractive option.
An RRSP can also help with financial planning. If you're just beginning a career, or know that you may be earning a higher taxable income in the future, and will therefore be in a higher marginal tax bracket, a good strategy may be to maximize your tax deduction by deducting RRSP contributions then. In the meantime, you can make use of a TFSA.
If you are planning to accumulate the funds to buy a first home, the RRSP is likely the better choice, since the refund created by the tax deduction can also be contributed to the RRSP, allowing you to accumulate funds more quickly than with a TFSA. In addition, the Home Buyers' Plan allows you to borrow funds from your RRSP (up to $35,000 in 2021, ($70,000 for a couple) without tax, provided it is subsequently paid back over a 15-year period.
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