Should I use an RRSP or a TFSA?

Start with a TFSA, when your income goes up add an RRSP.

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by MoneySense staff
February 15th, 2012

Online only.

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Confused by another set of letters? Don’t be. TFSAs, or Tax-Free Savings Accounts, are simply one more way to shelter your money from the taxman. The difference is that with RRSPs, you get a tax break when you contribute. When the money’s withdrawn, you’re taxed. For TFSAs, the process reverses. There’s no tax break up front, but the government can’t get its paws on your money when the funds are withdrawn.

So which is better? It all depends on how much money you make. Canadians earning less than $36,000 should use TFSAs, says Gordon Pape, author of The Ultimate TFSA Guide. The reason is that people with lower incomes can make more in retirement than they do when they are working, due to the government benefits you get at age 65. You always want to pay income taxes when your income is lower, so if you make less than $36,000 it’s better if the money is taxed before you put it in your retirement savings, as is the case with a TFSA. Plus, when you retire, the money you take from TFSAs isn’t considered income, so it won’t result in clawbacks to Old Age Security and the Guaranteed Income Supplement.

The same isn’t true for RRSPs.

If you’re just starting your career and earning in the $30,000 range, you could start with TFSAs and when your income goes up, you could switch to RRSPs. Not only will you get larger tax breaks, but you’ll have built up lots of extra RRSP contribution room from the years you were using a TFSA instead.

One comment on “Should I use an RRSP or a TFSA?

  1. If you were to invest $5,000.00 per year into a TFSA at an average compounded rate of return of say 10% for 40 years, you would have 2 Million dollars at your disposal. Assuming you only used the annual gains(10%) you would have 2 Hundred Thousand tax free dollars available. This would be an equivalent of a much higher taxable income. So where can you get that kind of return in this low rate environment? The Tier 1 Canadian Banks average more than 10% annual gain annually. This takes into account, share value increases, dividends paid and reinvested(DRIP) and usual(not always) annual increases in the dividend payouts. BNS, RY, TD, BMO have all paid continuously escalating dividends for well over 100 years. If you are even a casual student of recent history you will appreciate the strength of the Canadian Banks over those last 100 plus years. Hard to beat Canadian bank common stock. Buy the shares directly NOT mutual funds, ETF's etc. One little maneuver to consider is to pay the brokerage charges outside the TFSA so that your $5,500 annual investment is for the stock purchase only. If you re married and both of you do the same, you would be looking at 400 Hundred thousand tax free dollars between you. Since there is no cut off age limit and you like RRSP's and you didn't use all the annual gains, you could actually continue to grow the pot to keep up with any inflationary pressures that are sure to be there. Don't believe me, Google Canadian bank dividend history. Example: If you check the dividend history of BNS you will see that they have paid dividends for 182 years. Between dividend and share value increases plus share splits, the value is staggering.

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