TFSA vs RRSP – use one, use both or use none? (hint: its not the last one.)
Every time you pick up the paper, go to the bank, or simply take a walk around, you hear the mention of RRSPs, TFSAs, and many other three and four letter acronyms. We are lucky to have the tools needed to build wealth and save effectively, but unfortunately for the most part this information is often delivered in a confusing context, layered with jargon unknown to the average person.
So where do you start?
The TFSA vs RRSP
Well if you asked me that, the first question I would ask is how much do you make?
The reason I ask this is that one of the main reasons for using an RRSP is its tax advantage. You simply put in money now tax free, let it grow, and you take it out when you are older and retire. Income splitting is also a huge factor with the RRSP, which is explained here.
With an RRSP if you are in a higher tax bracket, the idea is that you will be in a lower tax bracket when you are retired, unless you find a way to make more money sitting at home rather than working, and therefore you get a tax savings on the funds you had put in when you were younger. This is the main benefit of an RRSP, the savings due to your tax bracket, remember the name of the game here is to pay the tax man as little as possible!
However, some people get caught in a trap here, if you are in a lower tax bracket, lets assume the lowest, and you put money into an RRSP, logically you will still be in that same tax bracket when you retire right? So there is no benefit there, and that is where you might want to think of a TFSA as your retirement vehicle.
Now the TFSA is much more than a retirement vehicle, and it really can be beneficial to anyone. Just imagine this little box that is yours, you can leave cash in there, you can buy stocks, ETFs, mutual funds you name it, and if you see some growth, it is all yours! Of course this comes with limits, literal limits, there is only a certain amount you can put in. Below we have provided a graph showing the growth of your TFSA, and a downloadable excel spreadsheet showing exact numbers of how your money can grow.
View the lifetime visual numbers here
This is a great product. However, because if you are on the lower income side, you can grow this wealth tax-free and there is a expected lifetime contribution room of roughly $400,000. If we are taking a 90 year life expectancy, that is 71 years of eligible savings. Also if you are on the higher income side, then this acts as one of the first steps in your financial plan, allowing you to tax shelter as much as you can before moving to a non-registered account.
To make it clear, if you are in the lowest tax bracket, and you have not maxed out your TFSA room, and aren’t able to fully maximize the $5,000 increase in limit every year, then consider forgetting about an RRSP for now, stick to the TFSA, keep things simple and you can build yourself the nest egg you need with minimum fuss.
If you are not in the above category, then we can do a deeper dive into why you should take advantage of the RRSP. As mentioned previously, the goal is to reduce your tax bill. Every dollar you put in your RRSP gets taken out of your current income, so you do not pay tax on that amount immediately, this reduces your current tax bill and you are able to invest this money in the years until retirement. Of course the flip side of this is that every dollar you take out gets added to your current income, so you are taxed on that. Another significant advantage is if you have a spouse earning a higher income, or vice versa, in this scenario you would be able to allocate these contributions over your individual limit and really take advantage of the long term tax savings. Of course, you can withdraw this money when you want, and when you turn 71, this must be converted into another acronym, the RIF, or retirement income fund. The RIF forces you to take out a minimum amount, essentially providing an income stream of your savings over time, so as it is depleted through retirement.
In an ideal world, you would max out your TFSA, max out your RRSP contributions and allocate the rest of the funds to a normal “non-registered” investment account. This would be tailored to your individual characteristics. The TFSA vs RRSP debate has been going on since the TFSA's inception, but the answer to the question is, in all honesty, it depends.
The Bottom Line
TFSA is a great way to tax shelter your funds whether you are in a high income bracket or low income bracket. Use this to your advantage as either your main mode of savings if in a lower tax bracket, or an important step of your financial plan if you are in a higher tax bracket. Tangerine has an amazing TFSA deal going on right now. The best part about them, TFSA or even a regular bank account, is they can offer a higher interest due to being an online only business. Less overhead = more returns for you. Become a new client and get up to $50 in bonuses and triple interest of 2.40%* on your first Tangerine TFSA Savings Account for six months. Check it out here.
RRSP reduces your taxable income, but the main point is that it creates a tax savings over your lifetime, money goes in at a higher bracket, and comes out lower. This creates an immensely useful tool for those in higher income brackets.