There are several registered accounts where Canadians can store their capital investments. Two of the most popular registered accounts in Canada include the Tax-Free Savings Account (TFSA) and the Registered Retirement Savings Plan (RRSP).
Both accounts allow Canadians to maintain equity investments, which makes them attractive to stock investors. One of the most popular financial instruments on the stock exchange is dividend stocks because they enable investors to create a passive income stream as well as build wealth through long-term capital gains.
Here we take a look at which one falls in between TFSA and RRSP is a better account to hold dividend stocks. Both accounts offer Canadians tax benefits and the opportunity to grow their capital by investing in various asset classes.
Alternatively, there are also some key differences between accounts that make them suitable for a specific set of investment goals.
Tax-free savings account
The TFSA program was introduced in 2009 as a way for Canadian residents who are 18 years or older and have a valid Social Security number to keep their money tax-free for life. Any contributions to a TFSA account are not tax deductible for income tax purposes, but any amount contributed, as well as any income generated in the account, is tax-free. These returns can be in the form of interest, dividends, or even capital gains.
Beginning investors may be confused by the name “Savings Account”. However, a TFSA works similarly to an investment account in that you can buy stocks, bonds, ETFs, mutual funds, and several other instruments.
There are no withdrawal rules with a TFSA and you can liquidate your investments at any time. However, there are certain deposit limits when it comes to investing capital in this registered account. For example, the TFSA contribution limit for 2021 is $6,000 and may change each year.
Registered Retirement Savings Plan
RRSP is retirement savings plan that you can set up and start contributing once you’re hired. RRSP contributions are tax deductible, which will lower your overall tax bill. Any income earned in this registered account is tax-free while the funds remain in the plan. You’ll have to pay tax on withdrawals when you receive payments from your RRSP.
An RRSP is basically a tax-advantaged account, while a TFSA is a tax-sheltered account. The RRSP was created to provide Canadians with tax relief and encourage people to save for retirement.
There are also contribution limits for RRSP account holders. This limit begins to be calculated from the moment of employment, so it also takes into account unused contributions from previous years.
For 2021, the RRSP contribution limit is 18% of your income or $27,830, whichever is lower. So, if you earn $100,000 a year, you could contribute $18,000 to an RRSP.
TFSA or RRSP: Where do you invest?
Now that we’ve looked at the essential differences between a TFSA and an RRSP, let’s see which registered account you should use to buy dividend stocks. Both accounts are ideal for holding capital investments, including dividend stocks. Before making a purchasing decision, you should consider your spending habits, profit potential, investment goals, and income level.
Ideally, you’d like to maximize your RRSP and TFSA contributions, but that’s not a luxury for most Canadians. According to a report from Wealth made simpleif you earn over $50,000 per year, you should prioritize investing in an RRSP and vice versa.
When you make contributions to your RRSP, you can deduct those contributions, allowing you to receive a tax refund based on your marginal tax rate for the year. Now, in retirement, you will be in a lower tax bracket because your earning capacity will be reduced.
So when you withdraw money from an RRSP, you will be taxed at a lower rate. In short, you should aim to contribute to your RRSP when you earn higher income and withdraw it during periods of low income, such as retirement or unemployment, thus taking advantage of the tax benefits.
For example, if Jessica earns $100,000 a year, her marginal tax rate will be close to 40%. By comparison, if she earns $40,000 in retirement, her marginal tax bill will be much lower. So her RRSP contributions can grow with her pre-tax savings, and she’ll be able to keep more of those savings in retirement.
The RRSP is also a good account for long-term investors or those who want to invest in foreign stocks. The tax office south of the border does not accept TFSAs as retirement accounts and you will have to pay non-resident withholding tax on the income generated from these investments.
According to financial planners, if you are in a lower income bracket (say less than $50,000), it is recommended to maximize your TFSA contribution limit first because it is not tied to your income. Lower income earners will also have a lower marginal tax rate and will be able to take advantage of unused RRSP contribution room in the future as their income levels increase.
Buying dividend stocks on a TFSA also makes sense if you want to cash out in the future once you’ve achieved your financial goals, such as saving for a vacation or even a wedding.
One last takeaway
We’ve seen that both RRSPs and TFSAs have some benefits, and two registered accounts should be part of your investing strategy. However, if you’re a long-term saver and earn more than $50,000 a year, you need to prioritize your RRSP contributions and hold dividend stocks here. Alternatively, TFSA contributions can be accessed at any time, better accommodating financial emergencies and lower-income earners.