Should you invest in an RRSP or TFSA?

TORONTO -- Instead of debating the merits of an RRSP or a TFSA, Canadians should consider socking away money in both types of accounts for the best tax breaks, financial advisers say.

But since that can be a challenge for most people, the decision of where to save boils down to what you want to use the money for, your income and how much you expect to earn in retirement.

"In a perfect world, people would be maximizing both their RRSPs and TFSA contributions," said Susan Stefura, a certified financial planner with Bespoke Financial Consulting in Toronto.

"But, of course, the world isn't perfect and most Canadians don't have the funds available."

Launched in 2009, Tax-Free Savings Accounts were created as a way to encourage Canadians to invest and save without paying taxes on those gains. In contrast, money socked away in an Registered Retirement Savings Plan generates a tax deduction when it is invested, but it may be taxed when it is withdrawn.

Stefura suggests Canadians look at their tax rate and what they expect it to be in retirement.

For those who are in a high income bracket and expect that their tax rate will be lower in retirement, an RRSP contribution will allow them to take advantage of the lower rate upon withdrawal without risking old age security (OAS) benefits.

"But if your income is too high (in retirement), you won't get that tax benefit and it will clawed back," Stefura said.

Factors to consider that might affect your taxable income in retirement: receiving a generous pension and not having a spouse to take advantage of income-splitting rules, the sale of a business or property, or the expectation of a large inheritance.

Certified financial planner Monique Maden notes RRSP contributions can only be made by Canadians until the age of 71. So older investors will want to consider a tax-free savings account if they have extra money to invest.

Money held in TFSAs are tax-free and are not factored in when calculating old age security benefits.

"All withdrawals from an RRSP count in the calculations, where the same amount of money taken from a TFSA isn't part of the OAS clawback because it's effectively out of the tax system," Maden said.

TFSAs can also provide more flexibility than an RRSP.

That's another reason why a TFSA may be more attractive to young savers who want to have an accessible emergency fund or save up for a large purchase like a car or vacation, said Chris Buttigieg, a senior manager of wealth planning strategy with BMO Financial Group.

"The TFSA makes sense early on because of the flexibility that they offer. You can make withdrawals at any time for any amount for any reason," he said.

Money can be taken out of an RRSP account before retirement but investors will be taxed on the withdrawl unless they are taking advantage of homebuyer or lifelong learning programs.

In an ideal situation, Buttigieg suggests taking the tax refund from an RRSP contribution and investing it in an TFSA to maximize the financial benefits.

"Use the two vehicles to complement each other so you can try to save as much as you can," Buttigieg said.