Should your savings be going into an RRSP or a TFSA? It really depends how well you’re getting paid, and whether you’re the type of person who tends to spend what they earn (on a Harley, expensive guitars and cars).  A TFSA is more likely the better option. If you’re the frugal type, then you can probably put more money away and forget about it. The higher contribution limit of an RRSP (and the tax savings when contributing) is ideal for you.  I once had a wealthy boss who drove a Ford Taurus until he retired.

First of all, if you can actually afford to invest the maximum (for 2019) $26,500 into an RRSP without borrowing money from somewhere else (i.e. you could be making bigger mortgage payments instead which makes the most financial sense) then you probably don’t need to read any of this – send a link to your kids or their kids.  However if you’re the average younger person who knows they should save some money, but struggle to do it then read on.

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I wish they offered the TFSA when I was beginning my working career, but all that was available was the RRSP.  And I cannot count the number of times I withdrew money from that RRSP account over the years – at considerable expense.  You may want to buy a condo, or need the money for rent if you’ve lost your job.  Take money out and the financial institution withholds a portion to compensate for the tax owing.  This of course is because you used the money to get tax deductions in the years you contributed.  The current rate of RRSP withholding tax is 10% for withdrawals up to $5000, 20% for withdrawals between $5000 and $15000, and 30% for withdrawals over $15000.  So if you need $30,000 to buy that used BMW you just must have, then you have to withdraw an extra 30%.  And kiss it goodbye because the odds of you replacing the money are slim indeed.

As an aside, The Canadian government’s Home Buyers’ Plan (HBP) allows first time home buyers to borrow up to $25,000 from your RRSP for a down payment, tax-free. If you’re purchasing with a partner who is also a first time homebuyer, you can both access $25,000 from your RRSP for a combined total of $50,000.  You DO have to replace the money though, or pay the taxes on it; again, good luck with THAT.  And you’ll have to struggle your way through the paperwork at tax time.

TFSA imageNo, you don’t get a tax deduction when contributing to a TFSA.  But let’s be real!  The money you kept from the government do to the RRSP tax deduction isn’t ‘saved’ is it? If you actually did save it, then the RRSP would be a superior option (it’s math).  But truthfully we squander it on dinners and other everyday items. So having after-tax dollars parked in a TFSA, earning interest or capital gains tax free for years is the better choice.  You can remove funds to pay for your Porsche, a down payment for a condo or house, or to survive a period of unemployment.  And you ‘can’ replace the money you took out as soon as the following year – BUT YOU DON’T have to.

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Bottom line – start your TFSA as soon as you can.  Get in the habit of making the maximum contribution, even if it means giving up a few night outs or new clothes.  It’s a source of emergency cash, a new car or home ownership  fund and a retirement plan all bundled into one.  When you get to be my age, unlike an RRSP you needn’t pay tax on withdrawals and it doesn’t have to be converted into annuity and become taxable income.

By the way, if you’re lucky enough to be selling a condo or a house and have never opened a TFSA, you can contribute a whole bunch of the proceeds and begin earning a rate of return tax free on the money.  The total contribution room since the program was launched is now $101,459.92 (see table). If you began contributing the full allowable amount back in 2009, and invested the money in stocks and bonds (self-administered or mutual funds or ETF’s), you’d have a whole lot more than $100,000 saved.

 

 

 

 

About the Author

Malvin Spooner is a veteran money manager, former CEO of award-winning investment fund management boutique he founded. He authored A Maverick Investor's Guidebook which blends his experience touring across the heartland in the United States with valuable investing tips and stories. He has been quoted and published for many years in business journals, newspapers and has been featured on many television programs over his career. An avid motorcycle enthusiast, and known across Canada as a part-time musician performing rock ‘n’ roll for charity, Mal is known for his candour and non-traditional (‘maverick’) thinking when discussing financial markets. His previous book published by Insomniac Press — Resources Rock: How to Invest in the Next Global Boom in Natural Resources which he authored with Pamela Clark — predicted the resources boom back in early 2004.

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