TFSA or RRSP - what is best for me? Seven tips to maximize your dough.
- Dante Winkler
- May 10, 2015
- 3 min read
When Registered Retirement Savings Plans (RRSPs) were created in 1957, they were designed to promote a tax-preferred way of saving. The concept of saving a portion of your income, and DEFERRING the payment of the tax on that income; until you withdraw it, promised tax-free growth for as long as it was invested.
At the height of the Great Recession - the Tax Free Savings Account or (TFSA) came into being (Jan 1, 2009). The concept is even simpler. Save your money (after you pay the income taxes on it) and whatever you do with it is no longer anyone's business.
Savers always had to pay ADDITIONAL taxes on their savings and investments, in the form of Interest/Dividend Income, and/or Capital Gains.
In both cases (TFSA/RRSP), there have always been contribution limits, but the TFSA is equal for everyone.
Unfortunately, I know a lot of people who thought a non-taxable investment gain sounded like a great idea, so they put in their $5,000 and bet it on one or more high risk/high reward investments... and promptly had no more money left in their TFSA. And here's the BAD part. They can't do anything about it. There is no tax loss, and that contribution room is lost, unless somehow they can "win" it back the next year. (Essentially if they put $5000 more in, and doubled it to $10,000, they could take the entire amount out, and "re-gain" the contribution room) But that's not the point.
If you look at the amount of tax you pay withdrawing your money from your RRSP, and/or the tax you pay on any unsheltered investments, it can really add up. Just like bank fees and everything else. So if you are careful with your choices in your TFSA; over the long term, you can create a tax-exempt cash source. And if you are able to leave it alone, and re-invest your profits you can really acelerate growth.
When you compare the two concepts with a view to your retirement years, it becomes apparent that the TFSA is the better choice for non-taxable income, but the RRSP may have had a bigger benefit if you were able to get significant tax savings during your working years.
Most likely we will need both. We may never be able to avoid paying taxes, but we can try and minimize them, and the TFSA is like a free pass for cash.
Everyone's situation is unique but here are some key ideas:
1. If you get a tax refund, put it in your TFSA. Even if some of that money is a result of your RRSP contribution. Essentially it is money that's yours anyhow, but take advantage of the lump-sum gift, and get it working for you, tax-exempt.
2. If your employer offers any kind of profit-matching plan, make sure you at least maximize THEIR contribution. (for example, you put in 5% of your earnings and the company will match up to 5%) It gives you at least a 100% return on your investment, regardless of how the tax situation is structured.
3. If you are able; contribute to both your RRSP and TFSA. Usually there is a "sweet spot" where your RRSP contribution gives the most effective tax leverage. Put the rest in your TFSA, and do your best to maximize it each year.
4. If you don't have a lot of money to set aside, put it in your TFSA. It is easily accessible if you need it, and all the growth you get is tax-free.
5. Consider NOT using your RRSP for a first-time home buyers plan. Although your home may grow in value, the loss of that capital in your RRSP will most likely not be worth it, but do it if it is your only option.
6. Make sure you are beating inflation (2%?). If your money is just sitting there earning minimal interest, you are most likely LOSING money. Speak with an Advisor and find out your risk tolerance, then select an investment that you feel comfortable with... or better yet select a few different ones.
7. If you are self directing your investments, try not to hold US dividend stocks inside your TFSA. The dividends are subject to a withholding tax, whereas in your RRSP they are not.
8. If possible, meet with your financial advisor, and tax professional at least once a year to make sure you are maximizing your savings, and minimizing your tax.
The key element is time. The longer your money has to grow, the more money you will have. So start now.
For ideas on where to find the money to "set aside" see my other post.
For additional reading material on TFSA vs RRSP - see this great article from the Globe and Mail:
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