One is never too early to be thinking about retirement and the two most discussed retirement tools are registered retirement savings plan (RRSP) and the tax-free savings account (TFSA). All Canadians should save for the future, ensuring that there are adequate funds for your retirement.
RRPS contributions can be used as an income tax deduction which potentially could allow you to receive a refund on your taxes. Taxpayers are allowed to contribute up to 18% of their earned income to a RRSP fund. The maximum contribution allowed for 2012 and 2013 are $22,970 and $23,820 respectively. A RRSP account basically defers the taxation on the income. It is assumed that in your retirement years, your earning would be significantly less than your working years, thus allowing your income in retirement to be taxed at lower tax rate. For someone earning over $120,000 per annum this could mean significant savings if no other income is earned in retirement. All withdrawals from a RRSP are treated as earned income and therefore are taxed. By age 71 all RRSP must be converted to a life annuity or Registered Retirement Income Fund (RRIF). In 2012 you are allowed to deduct any unused contribution made from January 1st 1991 to March 1st 2013. RRSP potentially could affect your Old Age Security payment. Once retirement income reaches $67,000, old age security payments are clawed back. The lost in old age security payment basically “acts” as a tax on ones income. The rule of thought is that individuals earning $40,000 or less while working should refrain from contributing to an RRSP as they risk getting lower old aged pension payment and should invest in a TFSA. RRSP is best suited for high income earners and workers not just starting their career. It should be noted that if you have an employer that matches RRSP funds then a RRSP is very useful.
TFSA contributions cannot be used to reduce your tax payable but principal or interest earned withdrawals are also not penalized or taxed. An individual can contribute up to $5,500 per year to the account and it is not limited by your taxable income. It also does not have to be converted to any fund like a RRIF.
TFSA does not affect your old age payments as the interest is tax free, and since the contribution was not used to reduce your tax payable the withdrawal does not increase your taxable income. The main benefit of the TFSA is that you can invest in any program allowed by an RRSP with the added benefit of withdrawing from it without penalty.
A TFSA is very useful for lower income earners or individuals just starting to work.
Speak to the experts at Sphinx Financial for more information:
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