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Tax Free Savings Account or paying down debt?

Tax Free Savings Account or paying down debt?

Tax Free Savings Accounts (TFSA) are really gaining traction and popularity. Everywhere I go, people seem to be interested in the TFSA because they are tax free. And why wouldn’t tax free appeal to you?

That being said, I am reading more and more articles that suggest TFSAs are better than RRSPs and will eventually make the RRSP obsolete as a savings vehicle for retirement. This is just ridiculous.

If you want my take on the new debate between RRSPs and TFSAs check out some of my previous work.

How about a new debate between TFSA and debt?

I’ve written about other debates in the past like the RRSP vs mortages, the RRSP vs the TFSA and the RRSP vs non-RRSP but let’s tackle a relatively new debate that seems to be quite common.

I see a lot of people with TFSAs invested in savings as opposed to stock, Mutual funds, etc. But many of these people are carrying debt and many times I wonder if this is the right strategy.

Tax Free Savings Account vs paying down debt

I recently sat down with a couple (let’s call them The Smiths) that have a $400,000 mortgage which is costing them 4.35% in interest. They also have $20,000 in a Tax Free Savings Account (TFSA) invested in a savings account at 1.75%.

When I asked them why they bought the TFSA, they said it was because their bank suggested they open a TFSA account because the money would grow tax free. Some of their friends and collegues also confirmed that a TFSA was the next best thing since sliced bread.

As much as tax free growth is good, the problem with the Smith’s situation is they are losing money every day they have the TFSA. Think about it from this mathematical perspective . . . the TFSA makes 1.75% but the mortgage is costing them 4.35%. If they used the $20,000 and put it against their mortgage, they would benefit by 4.35% instead of 1.75%.

Imagine I am the bank. Can I borrow $20,000 from you please? I will pay you 1.75% on that $20,000 and any interest I pay you is tax free. But at the same time I am going to lend you $400,000 and charge you 4.35%. Basically I make money off you anyway you look at it. No wonder the banks are so profitable!

A simple view

Let’s look at this chart. If you have $5000 in a TFSA earning 1.75% and a $5000 balance on a Line of Credit costing you 4.35%, you will be earning $87.50 in the TFSA but paying the debt costs you $217.50. That means you lose $130.

If you take the $5000 in the Tax Free Savings Account and pay down the debt, you stop losing $130. It’s pretty simple math if you ask me but yet I see a lot of people like the Smiths making the banks more profitable.

Do you have any thoughts or insights to add?


  1. My Own Advisor

    Good post Jim.

    Agreed with the comment that TFSAs won’t make the RRSP obsolete, but I would counter by saying this vehicle is better than the RRSP for most Canadians. Tax-free vs. tax-deferred is a huge factor.

    In your case study, agreed again, a TFSA generating 1.75% is costing The Smiths with their mortgage interest at 4.35%. However, what if The Smiths had no emergency fund? What if this was their only savings?

    While there is an opportunity cost, The Smiths might be rather prudent to keep at least $5K – $10K of their TFSA for emergencies, given they have a $400K liability.


    • Jim Yih

      Thanks MOA! Your points are well received. I wrote about this before so here’s my perspective:

      There are two issues to every decision you make – the logical part and the emotional part. What I presented here is the logical or numerical side because it’s really the only objective way to present it.

      Once you know the math, you can then overlay how you “FEEL” about the choices. Some people are good with money, they have good discretionary income and may not feel like they need a big emergency fund. Others can’t sleep at night without an emergency fund.

      For me, the math wins and I’ve always tried to apply my finances that way but everyone is different and has to do what’s right for them and their situation.

      Thanks for sparky the comment!

  2. Bridget

    I agree with the math, but what if the money in the TFSA is their only liquid cash? I think $20,000 is a cushy emergency fund in case something goes wrong, whereas if they put it all on their mortgage and then were faced with a financial crisis, they would be forced to use credit — likely with an interest rate higher than that of their mortgage, which would completely negate the savings!

    • Jim Yih

      Hey Bridget! thanks for stopping by!

      I guess the math says you lose money which makes it harder to get ahead financially. You have to weigh your priorities. The certainty of saving money today with the uncertainty that something may or may not happen.

  3. Bridget

    Just realized I said the exact same thing as the other poster. Whoops!

    • Jim Yih

      That’s not problem. As you can see, it allowed me to come up with a different answer than the first one.
      Good to hear from you!

  4. Janet Hutchins

    Debt sucks. See? That’s an even simpler equation.

    But you just did a great job of explaining exactly why debt sucks.

    Now if the banks would only increase the interest rates they pay and decrease the interest rates they charge…

  5. Juan

    It is sad, this is such simple math and yet so many people aren’t willing to take the time to sit down and do it.

  6. John

    1.75% in a savings account, that’s not an investment. What with the inflation rate being much higher. People don’t understand the purpose of a TFSA.
    Why not invest your money in a TFSA in an ETF, a REIT or a preferred share of one of the major bank. It would be easy to get 6 or 7%.
    Making money tax free, that’s what it’s all about and build for your retirement.
    Take advantage of cheap money.

  7. Paul

    Two somewhat general comments:

    1) With that logic, you will have a population of people with nothing but real estate equity as their source of wealth and,

    2) somewhat related, in essence you’re advising in this case to pay down your mortgage in favour of the TFSA @ 1.75%, which is equivalent to concentrating your assets and putting 100% of your investments into the real estate market.

    Admittedly, there are other benefits to your primary residence such as shelter, etc. But for those with rental properties? The US also had the same mentality towards real estate in that the market won’t go down. Comparing Canada to the US is akin to apples and Buicks, however if the housing market flatlines, or even slightly sells off, wouldn’t it make sense to have that TFSA and use the earnings to make additional payments?

    This is precisely the benefit of diversification. The case is even stronger when you add the ability to hold bonds in a TFSA.

    • Jim Yih

      Thanks for your comment Paul,

      The information in the article is based on real people but it is intentionally simplified to make a point. When it comes to financial and retirement planning, everyone’s situation is personal and has to incorporate all of the assets and circumstances.

      You point is well received and know that the Smiths have some RRSPs with mutual funds and alternative investments for diversification.


  8. Steve @ Canadian Personal Finance


    I like the simple example of why people need to evaluate their rate of return and borrowing costs before looking at the TFSA. I am in agreement with MyOwnAdvisor with using the TFSA in conjunction with RRSP. Even if you have a defined pension it makes sense to contribute to your TFSA.

    My mortgage(s) rates are variable and it makes little sense to pay them down aggressively when I can take advantage of the low interest rates with some stock market investing.

  9. Zila

    I pay 2.4% for my (variable) mortgage and earn 2.75% in my TFSA. The spread is no huge enough. Also I regard 20k in a TFSA a nice cushion if something unexpected happens.
    I think a LoC (at 3.5%) would cost me money, even if I don’t tap into it.

    • Jim Yih

      Thanks Zila, The same math looks much better in your situation than the Smiths! Thanks for sharing.

  10. marc larose

    It is so true, for me the math win. But from a saving standpoint it is at a loss. People just want to spend!!! if we can make them put money aside it is great! I fwe can lower their morgages great but then they turn around when they see that they can spend more through HELOC great. So now their mortgages is not paid no money aside and when retirement come around no flexibility. Now the trend goes into reverse mortgages. Well their goes their equity.
    No need to answer that comment it is just a comment! Keep the good work! One soul saved from indebtness great!!

  11. Kanwal Sarai @ Simply Investing

    Excellent post! I wish more people would take the time to crunch the numbers and see how much money they could save.

  12. asta

    can someone explain to me….before I visit my bank. I am new at this TFSA so my question might be primitive….can I contribute montly payments to TFSA and to have the highest interest 12%.,perhaps 200 a month. Or do I have to qualify for the highest interest. Use TFSA calculator a do the math?…looks promising in 10 years, 20 years. What is the catch here?….

  13. mb

    Joe Cdn needs to separate savings from debt, and “not” use savings to pay down debt. Your guidance to forego TFSAs to service debt perpetuates the over-spending problem that creates the debt in the first place. You should switch horses, and teach about needs vs wants and living within your means. Most people would be better to NOT pay off their CC debt – even at 19%. It’s about changing habits.

  14. mb

    Joe Cdn needs to separate savings from debt, and “not” use savings to pay down debt. Your guidance to forego TFSAs to service debt perpetuates the over-spending problem that creates the debt in the first place. You should switch horses, and teach about needs vs wants and living within your means. Most people would be better to NOT pay off their CC debt – even at 19%. It’s about changing habits.

  15. IB

    Good article. Also, people should think strategically about their “rainy day” fund. For example, if you pay down your mortgage instead of accumulate a rainy day fund earning 1% interest, you will save big. If a rainy day does come, use a line of credit (@prime + 1%) and pay it off when you renew your mortgage. For most people, the rainy day never happens, and they lose thousands by overpaying their mortgage.

  16. kar

    As an investment for my TSFA, could I choose to invest in my “mortgage”?


  17. Bess

    People should learn how to stick to their budget and
    not look for monmetary uncertainties.

  18. Kevin

    I thought I’d chime in and say that I’m using my TFSA as a tool to help me pay down my debt.

    my credit card is 16% and my line of credit is 7%, but I find that if I have the money in my hands, it is hard for me to refrain from spending it on something i “need”. the TFSA I have is through my work, the rate of return is quite high, and I can save up enough in 3-4 years of contributions to then transfer the money from my TFSA to my debt.

    The only downside is I’d like to benefit from compound interest, and taking out all of that money will interrupt that process. I opened my TFSA in October of 2013 and have had a 7% return since then. I can’t decide if I should try to pay my debt separately and take advantage of the compounding interest in my TFSA to benefit more down the line, or if I should just do as I said, and transfer money from my TFSA to my debt once I have enough saved up.

    Sorry for rambling, I’m still trying to figure out what to do here.

  19. Raymond

    Is it a good idea for a Disabled fellow over the age of 60 to use TFSA with Emerging Global Resource mutual funds to pay down a line-of-credit charging 6%?
    Also, his wife is over age 60 … claiming minimal CPP and draws up to $10,000 from a RIF.

    The Emerging Market fund is rebounding slowly (no DSC). It has been suggested that the line-of-credit should get repayed when his CPP, OAS and a Defined Benefit Pension kicks in.

    Is this the best tax saving method and investment strategy?

  20. James

    My current mortgage is at 2.2% whereas my TFSA is giving me 2% interest. In this scenario TFSA is better than mortgage because I have liquid cash on hand. (BTW sometimes having liquid cash is not good because you tend to overspend).

    But in most cases Mortgage payment is a better option that TFSA because TFSA interest rates will be always be very low when compared mortgage interest rates. If someone like me who has purchased a home at 20% down, doing extra mortgage payment will increase the home equity which is as good as liquid cash. Bank usually will provide you line of credit against your home equity at a very good interest rate (prime + 1%).

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