Monday, May 11, 2015
Registered Retirement Savings Plans (RRSP) VS Tax Free Savings Accounts (TFSA) what to do!
Most people who want to save for retirement will have this argument with themselves over time, and "time" it seems is really the key to determining whether or not you should contribute to your RRSP or to your TFSA in any given year.
Firstly let me point out what should be obvious to our readers now. These are not "Savings" accounts so much as they are "Investment" accounts. Within both vehicles you can purchase most kinds of investments from stocks to bonds, mutual funds, ETF's and real estate in the form of REIT's
Some people believe that splitting savings between these two investing vehicles is a safe bet, but in many instances they would be wrong.
One unique aspect of the Canadian RRSP (similar to a 401(k) in the U.S.) and the TFSA (similar to a Roth IRA in the U.S.) is that there is a "limit" to the contributions you can make in any given year but that limit "carries over" to the following year should you fail to contribute.
This fact alone should tell you how to best invest your money at different points in your life and career. For instance, when one is a young adult, say in your 20's, it is common that your income is much less than it will be later in your life, say in your 40's and 50's which are usually you "maximum" income years.
Knowing this, one simplified plan is to contribute as much as you can to your TSFA in those early years when your income is low, then, depending on your personal circumstances, gradually switch to the RRSP as your income increases later in life.
Why? Because it is better to reduce your tax burden on the higher income rather than the lower income, and the accumulation of contribution room over years, allows for a much larger RRSP deposit, thereby reducing your tax burden even further. Tuned in Canadians know that reducing your tax burden is a big part of retirement saving and planning.
If you were prudent and maxed out your TFSA during your 20's and into your 30's, "and" you invested well in that account ( It is really a tax free "investment" account, not just a savings account)
then you would have a considerable amount in your TSFA to tap into to ensure you max out your RRSP at the top end of your income earning years.
Here is a good primer on this very issue courtesy of BNN.
Is the RRSP headed for retirement?