Do you know the difference between a Tax-Free Savings Account (TFSA) and a Registered Retirement Savings Plan (RRSP)? Don’t be embarrassed if you don’t know the answer. More than a quarter of Canadians (27%) are unable to explain the difference between the two accounts1. While RRSPs and TFSAs share similarities, it’s important to understand how these accounts work and when to use one over another.
As the name implies, an RRSP is typically reserved for retirement savings (click here for more details). If you are looking for a way to grow your savings tax-free, but would like more flexibility to access your money, consider a TFSA. Like an RRSP, a TFSA allows you to invest in a wide variety of products, including stocks, bonds, mutual funds, exchange-traded funds and GICs. The right mix of investments will depend on your goals. A TFSA can be a great way to save for shorter-term goals, such as a home reno, a new car or building your “rainy day” fund. Before deciding on which investments to hold in a TFSA, consider your time horizon and savings goal, among other factors
If you’re in your peak earning years, an RRSP may be a better long-term retirement vehicle compared to a TFSA. You can deduct RRSP contributions from your income to lower your tax bill, something you can’t do with a TFSA. An RRSP also helps you save by deferring taxes into the future to when you’re retired, at which point you’ll likely be in a lower tax bracket. Although RRSPs offer a good way to save for retirement, TFSAs can play a role, too. A TFSA can provide a tax-free way to supplement your income in retirement, which can be useful if you’ve reached your RRSP contribution limit or have a reliable defined benefit pension plan through your employer.
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