TFSA vs RRSP: Why not do both?
Since TFSAs were introduced in 2009, there has been a lot of great debates over the RRSP and the TFSA. Here are some examples of the TFSA vs RRSP debate:
- My article on the new debate between RRSPs and TFSAs
- Canadian Capitalist surprised by some recent reports that suggest that a lot of Canadians would be better off contributing to a TFSA instead of a RRSP. These arguments forget to take into account the unique advantages offered by RRSPs.
- Jon Chevreau of the National Post writes about how some RRSP buyers might be blinded by the tax refund
- More recently, Jon Chevreau talks about the rising power of the TFSA
- Rob Carrick from the Globe and Mail, writes about why young people should not choose the RRSP
- MapleMoney gives 5 reasons to skip the RRSP contribution this year.
- Globe and Mail added one more article on the merits of the TFSA over the RRSP
Related article: Understanding the basics of the TFSA
It’s not mutually exclusive
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 so which is better?
They are both good
Let’s go back to the old debate between RRSPs versus paying down your mortgage. Some people think paying down the mortgage is better while others think buying RRSPs is better. Here’s the deal . . . both strategies are good. You can look at the math and the arguments on both sides and at the end of the day, either is a good financial use of your money. They are both productive ways to get ahead financially.
As a result, many pundits including me, suggest that one good strategy is to do both. One way to do this is to buy the RRSPs and then use the tax refund to pay down the mortgage. If that has become such a universally applied strategy then maybe we can apply it to the TFSA or RRSP debate as well.
Related article: TFSA or RRSP case study
Why not do both?
Let’s say you have $5,000 to invest. You could put the entire $5000 into the TFSA and be really happy about a liquid tax-free account.
On the other hand, you could put $5000 to the RRSP which will generate a tax savings based on your marginal tax rate. If we assume a marginal tax rate of 35%, that translates to a tax savings of $1750. You could then take the $1750 of tax savings and put that into an investment in the TFSA.
Essentially, you now got $6750 of use out of $5000. Let the government contribute to your TFSA so you can get more money working for you.
Not sure which is better, start with the TFSA
The TFSA will give you more flexibility. If you put money into the RRSP, you can’t get the money out without tax consequences. That also means you can’t move the money to the TFSA if you decide later, that was a better course of action.
On the other hand, if you put the money into the TFSA, you can always move the money to the RRSP later without tax consequences. As many of the experts above have pointed out, this may be ideal when you are younger and just starting out or in a lower tax bracket.
RRSPs are better for retirement
I like the TFSA. I think they have great merit but my concern has always been that they are too easy to access which makes them great spending accounts or emergency funds but not necessarily great retirement accounts.
Don’t get me wrong, they can be good retirement accounts for disciplined savers but statistics show that disciplined savings is lacking.
More often than not, when I sit down with people to go over the math, more people should buy RRSPs for retirement than those that should not. Don’t count out the RRSP as a way to save money for retirement especially through a group RRSP plan where the employer matches your contributions. Make sure you do the proper analysis.
“Better” is personal
All financial planning is personal. Just because the average Jane thinks TFSAs are better than RRSPs does mean that applies universally to everyone, especially you. Just because I say I like the RRSPs better for me, does not mean you should blindly follow my personal strategy. Here’s three rules of thumb to help you analyze your personal situation to make good decisions
- Use my one formula approach. If your marginal tax rate at the time of contribution is greater than your marginal tax rate at the time of withdrawal, then the RRSP makes sense.
- If you are not sure which way to go, the safer course of action is to buy the TFSA because it gives you the most flexibility in the future.
- If you can, do both. They are both great financial accounts so the ideal strategy is to have both. One way to do that is to buy the RRSPs first and get the government to put money into the TFSA for you.