Stash Your Cash: TFSA or RRSP

March 29th, 2012 is the the last day to contribute to your RRSP, and with only nine days are left before the contribution, it’s crunch time for most. It’s been four years, since the Federal Government introduced the Tax-Free Savings Accounts (TFSA), and the endless debate continues on whether a Registered Retirement Savings Plan (RRSP) or Tax-Free Savings Account (TFSA) is the best place to stash your cash.

Even a bigger kicker to the mid section is in the amount of people are still confused on what exactly is a TFSA, but that’s a whole other story by in it self.

So, back to decision making of where to stash our cash, TFSA or RRRP?

Both accounts provide solid tax advantages. We don’t pay no taxes on any investment growth for the funds inside either account. Yet, two different accounts, and two different sets of rules.

Let’s use my self for example. I’m a regular contributor to the RRSP, and a recovering saver, with fairly good savings discipline.  I have two TFSA accounts and one RRSP account, however  I’m looking to go on vacation, and would like to use my savings to fund my vacation. If I paid for my vacation from my RRSP, I’d be hit with fairly atrocious taxes on the withdrawal.

So, instead I’m going to pay for my vacation from my TFSAs. One of the beautiful parts of TFSAs, is the ability to save money, and knowing that I’ll be able to withdraw that money when needed without penalty.

We all should contribute to both our  RRSP and TFSA accounts. One thing to consider that as we fund these accounts is an idea of how we want to use the cash in the future. Knowing the differences between the two options helps:

TFSA

• Contributions are not tax deductible (you’ll not get a tax credit receipt to take to your accountant)
• No tax is payable on any investment growth
• The maximum you can contribute is $5,000 per year
• Withdraws are not taxed
• Any withdraws can be redeposited the following year (to a maximum of $5,000)
• Over contributions are penalized (contributors should keep any eye on how much they’ve contributed in any give year)
• Even with multiple TFSA accounts, the maximum contribution is still $5,000 per year, per person
• If you’re opening up a TFSA for the first time this year (2012), your maximum contribution will be $20,000 (4 years X $5,000 = $20,000)

RRSP

• Contributions are tax deductible (you get a receipt to take to your accountant for tax purposes)
• Your contribution changes every year, and is based on a percentage of your annual income
• Withdraws are taxed
• There is no tax payable on any investment growth
• Withdraws can only be redeposited if you have sufficient room in your RRSP
• Special non-taxable withdraws exist, such as First Home Buyers Plan and to for education purpose

TFSA account was designed to supplement RRSPs. If you’re one of the lucky few, who maxes out their RRSP contribution, TFSAs are a great alternative. They provide us with another great way to shelter a portion of your investment earnings from income tax. Since any money withdrawn from a TFSA is not subject to tax, TFSA accounts give us a solid option to save for short term goals such as vacations, car down payment or use it as an emergency account.

RRSP accounts were designed with one goal in mind, to help us save for our retirement. Any contributions to our RRSP accounts will reduce our annual income tax.  RRSPs were never designed for short-term savings, and any money withdrawn from it (outside of education and buying a first home) will increase your annual income, resulting in more taxes to be paid.

Saving long term and for retirement, RRSPs are pretty hard to beat. If you have savings, contribute them to your TFSA and RRSP accounts. Even a better option is to incorporate your savings into your budget, where portions of your pay go towards your TFSA and RRSP.

Remember, only nine days left before the contribution window for your RRSP account closes. Get moving!

Eddie