Net worth: Top savings vehicle for young people

You are never too young to start saving for retirement. Bruce has some opinions on the best way to get started.

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Question

My 22-year-old has just started his career. He was able to graduate without too much student debt and now has some money to put towards the future. Can you weigh in on the question of whether an RRSP or a TFSA is the best place to start?

Answer

The RRSP. RRSP. RRSP. The RRSP is the best place to start. Was that too subtle? Should I spell it out? Registered Retirement Savings Plan.There.Start there.

I don’t think the TFSA even comes close to the RRSP, but I know not everyone agrees with me. The basic argument in favour of the TFSA over the RRSP for young people is that your son is in a low tax bracket now and will likely be at a higher one in the future, so the tax deferral will be more valuable then. True, but I’d still start with an RRSP for a few very important reasons.

  1. Engrain the habit of long-term saving: The stats on RRSP contributions are dismal–just 26% of those eligible made a contribution in 2010–yet it remains such a great program for building wealth. If your son starts contributing now, before the pull of mortgage/kids/golf clubs becomes irresistible, there is a higher probability that he’ll be able to stick with the habit over time. Engraining the RRSP habit is the key thing, and is more important than the amount of the contribution itself.
  1. Make compounding count: Your son has time on his side and the earlier he starts saving for retirement, the easier it is going to be because he’ll keep earning interest on his interest. The TFSA is a great place to save for shorter-term goals like a house or a car. But the RRSP is better when it comes to retirement in part because it is harder to take the money out, so its more likely that he’ll leave it in and benefit from compounding over the next four or five decades.
  1. RRSPs still provide some flexibility: If your son decides that he wants borrow some money from his RRSP to put towards a down payment on his first house or fund further education, he can do that.  He can also contribute to his RRSP but choose when he wants to actually take advantage of the tax deferral, either now or when he’s earning more money and in a higher tax bracket.

Sure, your son could open up a TFSA in addition to an RRSP, but I would highly recommend that his first priority is to set up an automatic withdrawal, every pay day, moving money from his bank account to his RRSP.

RRSP first. Was I clear?

5 comments on “Net worth: Top savings vehicle for young people

  1. This isn't complletely accurate. To answer the question efficiently we need to know much money your son earns and his tax bracket which will vary by province.. An individual earning less than $41,544 would benefit more from saving in a TFSA vs. RSP. Simple reason all monies earned & contributed to a RSP will be taxed at one's full marginal tax rate upon withdrawal, retirement or not. It is more efficient to be saving to an RSP at a higher MTR so that you'll be taxed at a lower MTR when withdrawing at retirement.
    It's not clear cut that RSP is the right choice by any means especially if you're a lower income earner and being 22 this might be the case.

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  2. According to what I've been reading, the author is incorrect. As a previous comment states, a young person starting their career is likely not in hte highest tax bracket and would therefore benefit less from deferring the tax (assuming they will make more money and be taxed more later). Buying some solid REITs may be a good way to go as they pay out good rates but are heavily taxed. Buying them within a TFSA allows for the good rates and, income and tax protection.

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  3. Thanks for your comments Trevor and Jason. Valid arguments, but you're missing my point. The biggest challenge we have in this country is people engraining the habit of saving for retirement. Under 1/3 of people are contributing. This is a HUGE issue. I understand the marginal tax rate argument – and sure it would be great to optimize on tax – but I am way, way more concerned about people saving regularly for when they no longer have a pay cheque. And the RRSP is a better way to engrain that habit.

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  4. Do Both. Its all about discipline and nothing more. Pay yourself first and treat investing like bill payments. Skip the 3 or 4 trips to Tim Horton's everyday and you'll find its actually effortless with discipline. I'm 38 and with a middle class income I've done the complete package. Portfolio, RRSPS, TFSA, paid off cars, 2 houses, etc. etc.

    Discipline, discipline, discipline. If you can instill that in someone when they are 13 or 14 the rest is easy. And I mean that.

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  5. Do both

    Discipline is all it takes. Start with someone at 13 or 14 and instill financial discipline in them. By 22 its not too late but they'll never be as successful as someone who figures it out at 13.

    I did thanks to my grandfather and father and now that I'm 38 its the best advice I could give anyone. My four year old is now learning budgeting and discipline when it comes to spending his own money (albeit for a sucker at the candy store).

    Control your ability to handle finance through discipline and the rest is easy.

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