I’ll maximize my TFSA first, thanks
Some time ago, I returned home from an annual golf vacation, a “boys vacation” in Myrtle Beach, South Carolina.
Ottawa to Myrtle Beach (and back again) is a long drive, about 30 hours in total, 15 hours each way.
As you can probably imagine, with that much time to kill amongst a few grown men away from their wives for a few days, a host of interesting and surprising topics come up.
One of the topics that arose during our long drive to and from golfing fun was investing, specifically, TFSAs or RRSPs, which is the better investment choice?
I know you’ve heard the debate before: TFSAs are better than RRSPs, RRSPs are better than TFSAs.
Today’s post is about my preference: maximizing my TFSA before maximizing my RRSP account with some very simple reasoning.
So, let’s look at a few tax characteristics of the TFSA:
- Any income or gains earned in your TFSA (from interest, dividends or capital gains) are tax free as the name of the account suggests.
- Any withdrawals from your TFSA are not taxable to you. If you make a withdrawal from your TFSA that amount will be added to the following year’s contribution room. You don’t even have to report withdrawals on your tax return.
- You do not receive any tax deduction from a TFSA contribution; TFSA contributions are made with after-tax dollars.
- As soon as you’re 18 years of age or older, you can have a TFSA. There is no age maximum for this account – you can contribute to a TFSA until life’s bitter end.
- TFSA withdrawals are not counted as income (my favourite).
Overall, pretty amazing stuff folks and those are just the highlights.
Now let’s discuss the RRSP account:
- Any income or gains earned inside your RRSP are tax free until withdrawn.
- Contributions to your RRSP are not counted as income; RRSP contributions receive a deduction based on your marginal tax rate.
- Withdrawals from an RRSP are taxable to you. They will be taxed as regular income regardless of source (from interest, dividends or capital gains) at your marginal tax rate.
- You must convert your RRSP to a RRIF (then start withdrawing), buy an annuity or cash out this account in the year you turn 71. There is an age maximum on this account.
Still very impressive stuff.
I prefer to maximize my TFSA over my RRSP every time.
I’ll qualify this statement by saying the biggest advantage of RRSPs over TFSAs is the tax-deductible contribution you get today and the power it can provide if tax refunds are reinvested going-forward.
Simply put, RRSPs are an amazing tax deferral tool.
If you intend to save for a long period of time (e.g., for retirement over 20+ years) and reinvest your tax refund every year then RRSPs potentially have an advantage over TFSAs.
The RRSP refund is great but it’s actually temporary; you need to give it back at some point.
This makes reinvesting the RRSP refund year after year absolutely critical in my opinion to optimize wealth building – to take major advantage of an essentially long-term but not permanent government loan.
Another reason why I prefer the TFSA over the RRSP is this: simply not all Canadians can consistently max out their RRSP let alone avoid touching the RRSP-generated tax refund each year.
I guess it goes without saying that Canadians who can afford to maximize both RRSP and TFSA contributions would be doing very, very well. Good on them to do so.
The reality is many Canadians simply don’t have enough cash to maximize contributions to both accounts. That’s totally understandable:
- Canadians have a mortgage to pay off,
- They have other loans to pay off,
- They have kids to raise,
- They also want to live for today. Life is short after all.
For these reasons, if you had to pick just one account – max out the TFSA before the RRSP.
Over time, our government will likely find more compelling reasons to tax us. I just don’t see tax rates going lower over time. This will have an impact on RRSP withdrawals but not TFSA withdrawals.
In the end, financial planning is personal. That said, be reminded that TFSAs are a complete tax free gift every Canadian can benefit from.
My plan is to exploit this account for as long as the government lets me. I hope you consider doing the same!
What investment vehicle are you partial to and why? Any feedback or comments for my strategy?