RRSP vs. Tax Free Savings Accounts: the case for using both
Tax-time for most of us means finalizing RRSP contributions. As you plan, don’t forget to review the role of Tax Free Savings Accounts (TFSA). TFSAs are one of the most tax-favoured ways to save. As TFSAs are still fairly new, it’s a good idea to step back, refresh your memory and decide where TFSAs fit in with your over-all financial plan.
TFSA refresher. Here are the TFSA’s major features:
- $5,000 annual contribution limit, carried forward each year.
- Can be used to house any type of investment, including savings ac-counts, funds and stocks.
- You pay no tax on investment in-come and/or investment growth.
- Withdrawals don’t count as income (though if you withdraw, you’ll have to wait until the following year to replenish your account).
Differences from RRSP. Here are the main differences between TFSAs and RRSPs:
- TFSAs operate within the calendar year.
TFSA contributions are not tax deductible. - If you borrow to invest in a TFSA, the loan interest is not tax deductible.
- TFSA withdrawals don’t count as income (RRSP withdrawals are taxed at your marginal tax rate).
- TFSA withdrawals don’t affect
- Old Age Security, or Guaranteed Income Supplement eligibility (RRSP withdrawals do impact these income-tested benefits).
Which is better?
Both are equally important in my view. In general, RRSPs support long-term retirement savings. TFSAs support short-term saving for major purchases and supplement retirement savings, once you maximize your RRSP.
TFSAs in your overall plan. While this newsletter can’t replace personal advice, here’s are some general rules of thumb on when to use TFSAs as primary or secondary savings vehicles. This is the case in most instances, however, be sure to seek customized personal advice first.
Primary: TFSAs should be your first choice for general savings, home purchases and short-term investment plans. For retirement, it’s primary only if you’ve maximized your RRSP.
Secondary: TFSAs should be your second choice for a child’s education savings, after you use an RESP to maximize the Canada Education Savings Grant. For more ideas, read the article in a previous issue of Perfect Times: Your child’s education: RESP or informal trust? Both! available at perfectimes.com.
What’s on your mind?
- I’ve contributed to my RRSP and am getting tax back this year. Should I contribute to my TFSA and pay down my mortgage?
- Can I move my non-registered investments to a TFSA? Do I need a new account?
- I’m saving for a first home: should I save using a TFSA?
The answer: YES
Investment mix
It’s a common misconception due to their name that TFSAs apply only to savings accounts. You can have more than one TFSA, and each can contain different investments. TFSAs can hold not only interest-bearing accounts, but funds and stocks as well. The best investment mix for you is based on your personal situation. Here are some guidelines based on your savings objective.
- 1 year timeframe: 100% cash (a high interest savings account, money market fund).
- 5 to 10 years: 30% to 50% equity (equity mutual funds) and the balance in fixed income and/or cash.
- 10+ years: 50% to 70% equity, the balance in fixed income and/or cash.
Always seek advice before proceeding. I’m constantly evaluating the products and investments out there to save my clients time. Don’t hesitate contact us. There is no substitute for a professional opinion.
