“The rule of thumb is to invest in an RRSP and use the resultant tax savings to fund a TFSA contribution.”
In an ideal world, one would contribute to both a TFSA and an RRSP in the same year and benefit from both savings plans. Not everyone has this luxury, so the question often arises as to whether one should contribute to an RRSP or a TFSA. The answer is a resounding “It depends…”
A contribution to a RRSP is tax deductible, whereas a contribution to a TFSA is not. While both these savings plans offer compound tax-free growth, an RRSP contribution provides an immediate tax saving. Withdrawals from an RRSP are fully taxable, whereas withdrawals from a TFSA are not. If there is not enough free cash to fund both an RRSP and a TFSA, the rule of thumb is to invest in an RRSP and use the resultant tax savings to fund a TFSA contribution.
Where the marginal tax rate at the time of withdrawal from an RRSP is expected to be higher than the marginal tax rate at the time of the RRSP contribution, it may be better to make the maximum contribution to a TFSA first.
Other factors, such as the amount of time the funds will accumulate before they are withdrawn and the period during which the funds will be withdrawn, should also be considered.
The TFSA and RRSP rules are both singularly and collectively complex. A tax advisor should be consulted where both contributions cannot be funded in full, as the funding decision is fact dependent
TAX TIP OF THE WEEK is provided as a free service to clients and friends of the Tax Specialist Group member firms. The Tax Specialist Group is a national affiliation of firms who specialize in providing tax consulting services to other professionals, businesses and high net worth individuals on Canadian and international tax matters and tax disputes.
The material provided in Tax Tip of the Week is believed to be accurate and reliable as of the date it is written. Tax laws are complex and are subject to frequent change. Professional advice should always be sought before implementing any tax planning arrangements. Neither the Tax Specialist Group nor any member firm can accept any liability for the tax consequences that may result from acting based on the contents hereof.
