TFSA vs RRSP
One of the most common questions during the TFSA vs RRSP conversation is whether to maximize contributions to a TFSA or an RRSP first. To make an informed decision, it's essential to understand these two accounts.
What is a TFSA?
A TFSA is a Tax-Free Savings Account, a registered account ideal for saving towards short- to medium-term goals. You can use this account to save for anything and as the name suggests, all your interest earnings and investment gains are tax-free. I recommend you invest using this account and not solely for saving because investing helps you maximize its benefits.
What is an RRSP?
An RRSP is a Registered Retirement Savings Plan primarily used as a retirement savings tool. This account helps you plan for retirement and all your contributions are tax-deductible. The expectation with this account is to be able to make withdrawals during retirement when your tax bracket is lower so you can pay lower taxes. I highly recommend you invest in this account to take advantage of its benefits.
Now Let’s Compare Both!
What account should I max out first, the TFSA vs RRSP?
Remember, the goal is to take advantage of both accounts, max it out and invest through them. These Four Things just help you determine which account first, as you start your financial journey.
Current Financial Situation:
If you can only focus on one account based on your financial situation. I recommend the TFSA because it offers more flexibility to withdraw some money for any reason. Also, consider your level of income when determining this. This flowchart by Wealthsimple does a great job of simplifying and helping answer the question, it also ties in the FHSA account. I plan to review this soon!
Savings Goal:
If you have short-term financial goals, such as saving for a vacation or a down payment, or an emergency occurs, a TFSA offers more flexibility. With a TFSA, you can withdraw your money and get back your contribution room the next year versus an RRSP where you lose your contribution room and have to pay taxes on the amount withdrawn. However, having an emergency fund is one of the first things to do on your savings journey, and I recommend you have a revolving sinking fund for vacation or travel plans so you are not dipping into your TFSA.
Current vs Future Tax Rates:
Optimizing the RRSP could be advantageous if you anticipate being in a higher tax bracket now than in retirement. On the other hand, maxing out the TFSA might be smarter if you expect your income to rise in retirement. The thought process with this is you can take advantage of the RRSP being tax-deductible when you have a higher income vs a lower income because you get to pay less taxes.
Maxing out Both!
A balanced approach may also be beneficial, contributing to both accounts based on your circumstances. Using me as an example, I try to max out both yearly. However, I’m currently prioritizing my TFSA and FHSA first because my next goal is to purchase an investment property. I can get my TFSA contribution room back without any pressure to max it out. Even with this, I still make contributions to my RRSP to take advantage of its tax-deductible capabilities, and I’ve been maxing it out yearly. I know my income will be higher during retirement, and I have no fear of paying more taxes because all of my income will be enough for me during retirement.
Let me know if you have any question!
