WHY IS THERE A BIG DEBATE BETWEEN RRSP’s & TFSA’s?

In 2009, the Tax-Free Savings Account (TFSA) was introduced to Canadians. Since that time, TFSA’s have grown in popularity and as a result, there are lots of debates over which is better the RRSP or the TFSA. 

What does each investment do for you Immediately?

RRSPs give you an immediate tax deduction…

The most attractive feature of the RRSP is the immediate tax savings you get when you put money into the RRSP.  The value of this tax break is determined by the marginal tax rate that you are in.  This short-term tax gain is offset by future taxes when you take the money out of your RRSP.  When you take money out, you will pay tax based on your marginal tax rate at the time you take the money out (which should be a lower tax rate than at the time you originally put the money in).  Any growth inside the RRSP, grows tax deferred but eventually there will be taxes paid when withdrawn from the RRSP.

Tax Free Savings Accounts give you Tax Free growth…

Unlike the RRSP, there is no immediate tax deduction when you put money into the TFSA but there is no tax paid when you take the money out either. The appeal of the TFSA is actually the TAX-FREE growth on your investments within your TFSA portfolio. You don’t pay tax on any of the growth inside a TFSA.  That is its best feature.

Below we have the reasons…

What do you need this money for?

If you need to spend the money in the near future for a car, a kitchen renovation, or maybe for a vacation, the TFSA is a better option because using the money does not trigger tax.  However, putting money into a TFSA and then taking out on a regular basis kind of defeats the real benefit of the TFSA which is its long-term TAX-FREE growth. If the Tax-Free growth is the goal, then you might be better off using a high interest savings account instead of a TFSA as the savings vehicle.

Emergency Funds…

Most people will agree that a TFSA, conceptually, can be a great place for emergency money.  However, an emergency fund should not only be readily accessible but also a safe investment.  Putting safe investments in place with lower returns to remove market volatility concerns will also negate the true benefit of the Tax-Free growth.  If you want your TFSA to be a safe haven for your investment then you will probably get better results from a High Interest Savings account for your emergency money with zero risk involved.

Saving for your first home or for education…

While the TFSA and the NON-RSP (non-registered savings plan) seem like logical ways to save for a home or for education because they are not taxed, your RRSP does offer two opportunities to withdraw money through the First-Time Home Buyers Plan and the Lifelong Learning Plan. This requires you to pay back the loan overtime giving you a chance to pay yourself back in the long run. The only thing lost is the gain on the money while it is not in your portfolio.

There is no right or wrong answer…

One of the problems with the outcome of the TFSA or RRSP debate is it seems like people have to make the choice between one or the other which really is not the case. Both the TFSA and the RRSP have merits and a place in your financial plan.  

Why can’t you have both?

Both the TFSA and the RRSP have strong financial benefits that are good for you. One way to invest in both the RRSP and the TFSA is to invest in the RRSP first and then use the tax refund to invest into the TFSA.  

An example:

You could invested $5,000 into an RRSP, or you could invest the entire $5,000 into the TFSA.

But should you?

What should you do?

Well if you invest $5,000 to the RRSP this will generate a tax savings based on your marginal tax rate. 

Let’s say the marginal tax rate is 30% (this marginal tax rate has been chosen for ease of calculation), that is equal to a tax savings of $1,500. Now take the $1,500 of tax savings and invest that return into a TFSA.

So now you have $6,500 invested into your portfolio from your original $5,000 that you invested in your RRSP. Most people in reality just spend the tax savings on a trip or something they want which is normal when you find free money. But why not take advantage of that free money to increase your future investment portfolio.

So, which is better? 

TFSA investments which grow TAX FREE, or RRSP investments which grow TAX DEFERRED. They both have their own merits in your portfolio and it depends on what you need out of each. Tax savings today which is important to most at tax time, or if tax savings is not a concern then would you would want tax-free growth for the future. Now you can see why there is a debate.

Why does one have to be better than the other?

Why can’t you have both? Well you can but you have understand what each represents in your investment portfolio.

The decision is yours to make choosing one or the other or even both make great wealth sense where your investment portfolio is concerned. Is the debate over? No! But now you have an understanding of the merits of each investment and how they work…

As always seek professional advice when creating a plan for the future. The value found in the advice given could provide a bigger pot of gold at the end of the rainbow.