This article is all about your Tax Free Savings account vs. your Registered Retirement Savings Plan and which one you should be investing in. Obviously if you can afford to you should be maxing out both of these accounts if you have the ability to do so. This article assumes that, like me, you don’t have the ability to max both of these accounts currently. There are tons of opinions and articles saying that you should have six months income set aside before you start to invest. I strongly disagree with this sentiment. This is exactly what a TFSA is for in my opinion. The only thing you might want to consider if you are investing with a TFSA without a nest egg you should probably start out with ‘safer’ investments.
– Lowers your income for the year allowing you to either receive a tax refund or reduce the amount you owe on your taxes (You will get back roughly 30% of what you put in to your RRSP back on your taxes)
– RRSP compounding. You can grow your RRSP exponentialy by putting any tax refund you get back into your RRSP, increasing your contributions for the next year and allowing you to get money back on the money you got back, and so on if you continue to put your refunds into your RRSP.
– Any dividends in any currency do not get taxed at all
– You pay no tax on any capital gains before withdrawal
– First time home buyers plan. You can use up to $35,000 out of your RRSP to buy your first home. You can also be reconsidered as a first time buyer if you get divorced or leave a Common-law relationship, or if you sell your home and do not buy another one for 4 years.
– Your money continues to grow even while you pay back your first time home buyers loan
– Taxes. Any money you pull out counts as income and will be taxed accordingly. This is the biggest disadvantage of an RRSP by far.
– Must be closed down by age 71 (usually by transferring the money to a RRIF)
– After 71 you must pull out a minimum percentage every year increasing from 5.28% at 71 to 20% at age 95. This could lead to a large tax bill if you have a large sum in your RRSP at age 71.
– You can’t really pull any money out until you retire, because it counts as income you will be in a high tax bracket if you pull the money out while still working
– No taxes-EVER! (The government won’t even look at it until you hit $500,000, and even then it’s just to make sure you are following the rules)
– Can be pulled out at any time with no penalties
-Dividends from Canadian exchange stocks are tax free
– Dividends from foreign stocks taxed 15% and you don’t get it back
– Does not affect your income or tax return
Obviously the list is much shorter overall for TFSA as it is a simpler account overall. The best time to be investing in a TFSA in my opinion is if you don’t have 6 months to a year worth of income set off to the side already and you already own a home. If you have been able to invest in a TFSA since they became a thing in 2009 you can put in $69,500 into your account including 2020. For the average person this will be as much or more than you make in a year after tax and that doesn’t include any growth in your investment value of that money. Once you have 6 months to a year (even better) worth of income set aside in a TFSA then it’s time to start thinking about your long term plans and which account will benefit you the most to put your money, or the largest portion of your money into.
RRSP is 100% your best bet if you have not bought your first home yet. You have the ability to pull out up to $35,000 towards a down payment on your first home and payback that money later allowing your investment to continue to grow even as you are paying it back. Once you buy the house though, you should definitely build up a safety net using your TFSA. You never know when you might lose your job or have to go on long-term disability or something equally undesirable. Not like global pandemics or recessions ever happen anyway right?
After you have bought a house and built up a safety net then you have to consider your investing style and retirement goals to know which account is the best for you (Assuming you can’t max out both). Long term your RRSP will net you better returns than a TFSA, the only drawback being that you have to pay taxes when you take it out. With the RRSP you get to hopefully take advantage of an additional tax refund which you can also invest as well as paying no tax on any dividends you get allowing you to invest in foreign markets easier. The TFSA only really takes the cake as an emergency fund or to top up your RRSP income to keep your taxes lower once you retire. The only other place a TFSA is better is if you are an individual investor and you happen to hit the next Amazon or Facebook before they are big, in which case your millions will be tax free. You have to like a long shot right?
Obviously as the long term investment the RRSP is significantly better. You can look up any RRSP vs. TFSA calculator and it will show you the RRSP gets better overall returns (possibly a few hundred thousand dollars more). That being said the TFSA is a great safety net account and if you are like me you make enough to slowly max out the TFSA while contributing to your RRSP at the same time. Another thing to keep in mind is that for the RRSP to truly beat the TFSA in gains you have to invest whatever tax savings you get from your contributions back into your RRSP every year to help compound your contributions and growth, otherwise if you put the same amount in each and get the same percentage growth the TFSA wins every time because it is tax free to pull it out. Just some food for thought.