Boss Blog: June 14, 2017
RRSP versus TFSA…..Who wins?
The financial world has become full of instant information. You can turn on your computer or phone and find out about all sorts of investment products within seconds. Here is the problem: What do you do to make your life better? Getting the information is one thing, knowing how it relates to your specific situation is a completely different animal. A huge problem is the banks not being able to provide a personal touch when recommending a product. If you don’t believe me, walk into a bank in February and see if the teller recommends opening an RRSP, even if your bank balance is $500. Don’t get me wrong, it’s not the banker’s fault, it’s the bank’s fault. The system is in place to hit bonuses, climb the ladder, and get the next promotion. It’s sad but true. This leads me to a common question I get from my clients. As a financial advisor, I often get asked: “What should I chose, A Tax-Free Savings Account (TFSA), or a Registered Retirement Savings Plan (RRSP)?” The first step is to truly understand what they are and then you can an informed choice on which suits you. In this post, I will describe each one and then give my recommendation on whom it may suit best.
Registered Retirement Savings Plan (RRSP)
The RRSP was introduced in 1957 to promote retirement saving by employees and self-employed people. It soon became the investment location of choice for the majority of Canadians because of its multi-faceted tax benefits. Contributing to an RRSP lowers your taxable income which means immediate tax savings. Tax is then deferred until you withdraw and then paid at your marginal tax rate which will more than likely be lower than your prime working years. Contribution limits are the lesser of 18% of your earned income or $25,370 (for the 2016 tax year). You can contribute to an RRSP until the age of 71 and then you have to convert your RRSP into a Registered Retirement Income Fund (RRIF) or an annuity. For those paying a large amount of tax, the RRSP is very powerful. A person who makes $50,000 annually can contribute up to $9,000 per year in their RRSP. Maxing out their contribution brings their taxable income down to $41,000 which means thousands in tax savings that year. That’s pretty nifty way to save for the future.
Eligible Investments: Stocks, bonds, GIC’s, mutual funds, ETF’s, cash and other various investments
Tax-Free Savings Account (TFSA)
The TFSA came into effect on January 1st, 2009 and was introduced by the then minister of finance Jim Flaherty. The C.D. Howe Institute said of the TFSA, “This tax policy gem is very good news for Canadians, and Mr. Flaherty and his government deserve credit for a novel program.” I couldn’t agree more. The TFSA was meant to help Canadians save for various purchases in life. Essentially it was made to be the day-to-day RRSP that allows Canadians to save for the future and avoid going into debt. Generally speaking, the TFSA is for more immediately objectives like saving for a home down payment. One thing I have mentioned in the past is that the TFSA should not be overlooked as a retirement savings vehicle. Its power lies within the fact that as long as you stay within the contribution limits you can withdraw all your funds tax-free. That’s a beautiful thing. Your withdrawals are not lost forever in terms of your contribution room. You regain any room you had the year following a withdrawal. That’s beautiful as well. The current contribution limit is $52,000 for all those 18 years or older during the eligible years, 2009 and later. That is sweet little lump you can use to get your nest egg going.
Eligible Investments: Stocks, bonds, GIC’s, mutual funds, ETF’s, cash and other various investments
Where I Stand
As a general rule, the TFSA is for more immediate goals whereas the RRSP is for longer-term goals. The problem with that general rule is that it is far too simplistic for a dynamic population. It all really depends on what your objectives are in life and what your circumstances are. For people looking for immediate tax savings, the RRSP is invaluable. For those who pay very little tax the RRSP doesn’t quite make sense for them, so go with the TFSA. In my opinion, it should be everyone’s goal to max out their contribution room on their TFSA. It might not be easy to come up with the $450 a month to do so, but it is possible. The reason I think this is so important is that unlike the RRSP, the tax isn’t deferred. You never pay tax on withdrawals from your TFSA so getting that maxed out is huge. I firmly believe that the TFSA will be the retirement vehicle of the future and it shouldn’t be overlooked for that task. That doesn’t mean that the RRSP has been replaced, just that co-ordination of the two is necessary.
Quite simply I believe that everyone should have a TFSA. I also believe that RRSP’s are extremely important, but only if immediate tax savings are a goal. Ideally, all Canadians would have both and max them both out. This might not be possible but it is definitely a goal worth shooting for. Starting a savings plan is the key. Analyzing your current plan is also important. For me, showing clients the benefits of both accounts is one of my most favorite tasks as a financial advisor. Think of both accounts as buckets where you store money and can make it grow. The only difference being is how they are taxed. We all agree that saving money in the form of taxes is amazing. Saving for your future is even better!
https://budgetboss.ca/boss-blog-stephen-harpers-greatest-victory-must-read-tfsas/
Email – joe@budgetboss.ca
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