This post will help me to organize my ideas about whether it is better to invest in a Registered Retirement Savings Plan or a Tax Free Savings Account. Of course, it is best to maximize them both, but this post is for those (like myself) who are unable to do so).
- can hold any investment (within reason) within your RRSP
- get an immediate tax rebate from your deposits (so if your marginal tax rate is 40% and you invest $1000 into your RRSP, you get $400 back from the government)
- interest grows tax free inside your RRSP
- you must begin withdrawing at age 65
- you get taxed on any amount that you withdraw (you are deferring your taxes on this money...instead of paying them now (when you probably have less money), you will pay them later (when you probably have more money)
- maximum contribution rate is 18% of your previous year's income up to a maximum of $21000 less the Pension Adjustment on your T4 slip
- even though it is called a "Savings Account" you can still hold most investments within your Tax Free Savings Account (I have a bond index fund for mine)
- interest grows tax free inside your TFSA
- you have already paid taxes on your money now, so no immediate tax benefits, but when you withdraw the money, you do not have to pay taxes on it
- maximum contribution is $5000 (although this is expected to go up slightly as time continues)
From a mathematics standpoint, lets show what is the best deal for people to do, and then the reality:
My example will be a single $5000 deposit, earning 5% per year, at a tax rate of 35%, grown over 10 years.
- $5000 invested, $1750 credit now,
- if you reinvest this $1750, you will end up with $10,995.04 at the end of ten years
- assuming the tax rate is still 35% when you withdraw, you will have $7146.78
- $5000 invested, $0 credit now
- valuation after ten years is $8144.47
So what is the better option? It is different for everyone, but this is how I see it:
RRSP - great having a tax break now! Even though it ends up as a little less money in the long term, most adults are in a worse current financial situation than they are in the future. The other sad reality is that the $1750 credit I don't think is always reinvested, making the TFSA a much better plan. The final benefit to an RRSP is that the money is locked away (at least until you buy a house), so that you don't have access to it.
TFSA - financially this makes the most sense, but there is the human factor to consider. This money is not locked in. There is never a penalty to withdraw, so if you need money you can go into this fund. As long as you consider this money in your TFSA to be retirement money that you cannot touch, this is the better option.