Where to stash your cash: RRSP or TFSA?

Both provide tax advantages — there’s no tax payable on investment growth on funds held inside either account. However, each has its own set of rules. Consider Scott and Jennifer, newly married and saving for a trip to Europe.

“We’re both good savers and have enough in our RRSPs to cover the cost of the vacation,” says Scott. “The catch is we’d be hit with taxes on the withdrawal. For us, it made more sense to open TFSAs that allow us to save money knowing we’ll be able to withdraw it when we need it without penalty.”

But Scott says opening TFSAs didn’t mean ignoring their RRSPs. “The tax refund we’ll get in the spring from contributing to our RRSPs is an added bonus. Plus, it will come at the perfect time — just before we plan to leave.”

Whether contributing to an RRSP or a TFSA, the main things to consider are when and how you want to use the funds. It’s also important to understand a few of the key differences between the two options:

RRSP

• Your contribution limit is based on a percentage of your annual income
• Contributions are tax-deductible
• There is no tax payable on investment growth
• Withdrawals are subject to income tax
• Withdrawals may only be redeposited if you have sufficient additional contribution room (once withdrawn, you never get the contribution room back)

TFSA

• You may contribute $5,500 a year ($5,000 before 2013)
• Contributions are not tax-deductible
• There is no tax payable on investment growth
• Withdrawals are not subject to income tax
• Any withdrawals may be redeposited in subsequent calendar years

When it comes to saving for retirement, RRSPs are pretty hard to beat. Your contributions reduce your annual income tax. And, assuming you’ll be in a lower tax bracket when you draw the money out, you’ll save substantially on the overall amount of tax you pay. They are usually not a good option for short-term savings, however, as money withdrawn from an RRSP will increase your annual income and may result in your having to pay more taxes.

TFSAs were designed to supplement RRSPs. If you’ve maxed out your RRSP, they provide you with another great way to shelter a portion of your investment earnings from income tax. Because withdrawals are not subject to tax, they are also a good option for saving for shorter-term goals such as the down payment on a home, a vacation or an emergency fund.

Simply put: If you have adequate savings, it’s usually advisable to contribute to both an RRSP and a TFSA. To help determine the best savings strategy for your needs, consider:

• Your savings goals
• When you expect to withdraw the funds
• How likely you are to need to withdraw the funds sooner for other needs