So, which comes first, your registered retirement savings plan (RRSP) or tax free savings account (TFSA). Before the February 29 deadline, many Canadians will be considering whether an RRSP or TFSA is better for their future. As a refresher here are the basics:
An RRSP is a tax-deferred savings vehicle that allows Canadians to help fund their retirement. Contributions are tax deductible. This means that the individual's taxable income is reduced by the amount contributed in a given tax year. A TFSA is a flexible, registered general-purpose savings vehicle that allows Canadians to earn tax-free investment income to meet lifetime savings needs more easily. You can deduct contributions to your RRSP, but not your TFSA. However, withdrawals from you RRSP are taxable, but TFSA withdrawals are tax free.
What are the limits?
There are limits to how much you can contribute to both. Your RRSP contribution limit appears on your notice of assessment (NOA) that you received after filing your tax return last year. For your TFSA you can contribute $5000 per calendar year and have been able to do so since 2009. If you have not made any contributions, your 2012 limit is $20 000.
Wait…what about self directed RRSPs and mortgage investments?
Canadian tax regulations allow self-directed RRSP funds to be used for a non-arms length mortgage investment, provided that the mortgage is insured. There are three different ways to use RRSP money to invest in real estate:
1. You borrow from your own RRSP to buy your first home (withdrawals must be repaid within 15 years).
2. As an investor, you borrow from your own RRSP or that of a family member. The money is borrowed in the form of a 1st mortgage only and is fully insured by CMHC.
3. You invest your RRSP money into someone else’s real estate. It can be residential or commercial, vacant land or recreational property. The big difference between this method and 2 is that the “someone” cannot be related to you
Now that I am confused....which do I choose?
If you earn a low-income and perhaps you are young or a student or on parental leave and exect to earn a higher income in the future, a TFSA is the way to go. Also, your RRSP contribution will not save you as much tax today as it might later. RRSPs offer a psychological advantage because many people are hesitant to make withdrawals because of tax implications. For real estate investors, RRSP’s act as a flexible vehicle towards an investment property. The choice is yours.