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Use tax-free plans to your advantage

Deciding upon the best way to invest for your retirement can be a taxing problem. Should you invest in RRSPS or TFSAs?

Both plans allow you to sock away cash for the future, but there are key differences in how the government taxes them. As the acronym suggests, tax free savings accounts allow you to put money away forever, without paying the government a tax. RRSPs (registered retirement savings plans), on the other hand, have an immediate tax-deferral.

So which savings plan is better? The truth is, neither. There are advantages to both depending upon your financial situation, your income and the future retirement you hope to have.

The idea behind an RRSP is that you save now and build a nest egg for yourself and at the same time, the government gives you a break when you file your income tax return. You pay no taxes now and the investment may help because you might even get a tax return with some cash on it.

The catch is that someday that tax deferral you benefitted from at the time of investment must be paid. The amount of the RRSP that is cashed in will be added to your income of that year, and you will be taxed according to whatever income bracket it puts you into. If on that day your retirement income is less, you can use those RRSP funds in an affordable way.

“The money you set aside will create wealth. As it grows and compounds, the interest you make replaces any dollars you take out of your RRSP account,” said Laszlo Szojka, a financial advisor for D.W. Good Investment.

If you made a yearly contribution to RRSPs, Szojka suggests reversing it so that in retirement you get an annual income from that savings plan.

“You will pay taxes on it, but you will be in a lower tax bracket,” Szojka said, adding that the yearly withdrawal might be divided by 12 so that it becomes a monthly addition to your pension.

TFSAs are another tool that would-be investors can use. No taxes will ever need to be paid on these funds, but neither is there an advantage at the time of investment.

As with RRSPs, TFSAs must be registered with an investment broker or financial institution. The maximum annual contribution is $5,500. If you only invest a portion of that $5,000, you may carry the balance forward. For example, if you put $3,000 into a TFSA last year, this year you can add the $2,500 remainder to this year’s allowable contribution.

The money may be invested in the same funds you invest your RRSPs into, including bonds, mutual funds and mortgages. All compound increases will also be tax-free, even when you take the cash out.

The TFSA advantage doesn’t extend to financial failures. If your mutual funds tank, the losses from TFSAs cannot be claimed on your income tax return.

TFSAs make good emergency funds because of the tax-free advantage when they are cashed. If your income is reduced, if you need new winter tires or if you want to take a vacation, you may withdraw those funds without a tax penalty.

There are advantages to both plans. The ability to have ready cash, that is compounding and building funds for a rainy day is attractive, but so are the tax-deferral abilities of RRSPs. TFSAs allow a maximum contribution of $5,500. The maximum RRSP contribution for 2017 is 18 per cent of your 2016 income. If that 18 per cent allowable contribution is more than $5,500, you may be able to build your savings more quickly, while you realize a tax break now.

Susan Jones: Susan Jones has been a freelance writer for the St. Albert Gazette since 2009, following a 20-year career at the St. Albert Gazette. Susan writes about homes, gardens, community events and people.