Tax-Free Savings Account, or TFSA for short, is the best investment account available in Canada. There, it’s just that simple :) and I’ll tell you why if you read on. It was recently created compared to its competitor, or should I say, sidekick :) The sidekick in question is the Registered Retirement Savings Plan (or RRSP). It has been around for quite a while and many are struggling deciding between which account to use from time to time. Lots of efforts goes on at the government level to have its citizens save for retirement and the rainy days.
When it was first announced, I jumped on the opportunity to invest my savings in a TFSA account. I can grow my savings Tax-Free and I can withdraw it when I want. If I want to, I can even transfer it to its sidekick – the RRSP :) and I can leverage the tax refund if I so desire. When I think about my TFSA account, I don’t have to extrapolate 25 years down the road and think about what my tax situation might be, how it will impact my OAS and other benefits but the RRSP account has me looking deep into the crystal ball…
While the TFSA is the best account when taking a thousand foot view, there really is a scenario that works best for your personal situation when choosing between TFSA or RRSP.
TFSA vs RRSP
The 2 accounts are really sidekicks and meant to be used together but for many, it’s a tug of war to pick one. When there is only enough fund for one and you must choose, I say pick the TFSA account especially early in your career when your income is relatively low.
Why is the TFSA the best investment account you may ask? Let me outline the benefits:
- [Thumbs Up] Tax-Free Growth
- [Thumbs Down] $5,500 annual contribution limit (as of this year, previously $5,000)
- [Thumbs Up] No Withdrawal Penalties
- [Thumbs Up] Withdrawals Are Not Considered Income – this is huge in retirement – let’s hope the government doesn’t adjust it :)
- [Thumbs Up] Withdrawals amount are added back to your contribution room for the following year
The only drawback on the TFSA is the small contribution we are allowed to do. However, the TFSA account can only be defined best investment account by comparing it so let see what the RRSP account has:
- [Thumbs Up] Tax-Free Growth
- [Thumbs Up] 18% of gross contribution limit (cap at $23,820) – a much larger cap
- [Thumbs Down] Withdrawals Are Taxed as Income
- [Thumbs Down] Withdrawals amount do not adjust future contribution room – once it’s used it’s gone.
The Thumbs Down on the RRSP withdrawal is based on the fact that your income defines the tax situation and since everyone’s situation is different, it’s really difficult to assess the future income tax of a family. All is hypothetical but being taxed is definitely worse than not being taxed. One question to even ask yourself is if the tax on RRSP withdrawal is worst than the dividend tax in a non-registered account …
Here is what it can look like for a young individual or family.
- Invest in your TFSA for many years. Max it out if you can.
- At the point you want to purchase a place, make a $25,000 RRSP contribution (at least 3 months prior to a withdrawal) and use the tax refund to add to your down payment. ($25K is the maximum for Home Buyer’s Plan -HBP)
- You can add to your down payment by withdrawing more from your TFSA if you want.
- Keep on adding to your TFSA and invest it wisely
- One day, you can make a withdrawal to accelerate paying down your mortgage or just to pay for a car
- If you can, save more and keep your TFSA for your retirement
For an older family with RRSP savings, here is what your TFSA roadmap can be.
- Find ways to add to your TFSA just like you would do for RRSP
- Use your TFSA as a lump sum mortgage pre-payment if that’s the most important goal
- Keep building your TFSA
- Use your TFSA wisely along with your other accounts to minimize taxes in retirement or near retirement.