Tuesday, February 19, 2013

RRSP vs TFSA

TFSAvsRRSP
It seems Canadians have been bombarded with the notion that the RRSP is the ideal way to save for retirement. Now that its baby brother, the TFSA has been introduced, there is a common question floating around the country asking which one is better. No matter how many “experts” try to answer the question, the fact still remains that:


The only person who can answer that question is You!

There are so many factors that come into play that there can’t be a definitive answer for everyone. That’s why it’s extremely important to learn as much as you can about where you are putting your life savings. I can’t tell you which one is better, but I can teach you everything I know about them and from there you can make your own educated decision.

I could quote the top points about the RRSP and the TFSA and hit the publish button but what good does that do? I actually called the CRA with some of my own personal questions so I could be as accurate as possible with information that I think is very important for my readers.

Round One: TFSA


The TFSA was first introduced in 2009 as way for Canadians to save their money tax free. There is no tax paid on the investment income or on withdrawals from a TFSA which gives Canadians an even greater incentive to save.

Contribution Limit. We all know that you can contribute up to $5000 a year since 2009 which means the current amount we can have in a TFSA is $20,000 in 2012. What you may not know is that the $5,000 TFSA dollar limit is indexed based on the inflation rate. The indexed amount will be rounded to the nearest $500 which means in 2013, the amount you will be allowed to contribute will be $5500 per year. I asked if every year since the TFSA was introduced would have a $5500 limit and the answer was no. Can’t blame a guy for trying! Stephen Harper made an election promise to increase TFSA contributions to $10,000 once the federal budget is balanced. I won’t be holding my breath for that promise.

Misconceptions of TFSA.  By calling this vehicle a tax free SAVINGS account, a majority of Canadians think that’s exactly what it is. The CRA had to send out almost 72,000 letters to Canadians in 2010 because they over contributed in 2009 mostly by taking money out and contributing the same amount back within the same year. In 2011, the CRA had to send out almost 103,000 letters to people who over contributed in 2010 and 10,000 of those letters were sent to the same people who over contributed in 2009.

Just in case you are still unsure how the TFSA works here is a perfect example:

2009- Deposited $5000

2010- Deposited $5000 then withdrew $3000 for vehicle repairs.

2011- Deposited $5000 for yearly contribution and the $3000 from the  previous year’s withdraw.

Do not deposit more than $5000 a year unless you have room from previous years! Wait until the following year to replace any money you withdraw from your TFSA account.


You there, Stop! Don’t even think about it! Call the CRA before you deposit any money to make sure you will not be over contributing. 1-800-959-8281

Truly Maximize Your TFSA. I have often read advertisements that say a TFSA is a perfect way to save for that vacation or a new car because you get to keep all the interest you make. Sadly, majority of Canadians open a TFSA at a financial institution as a high interest savings account and are only offered an interest rate of 1.15% which isn’t much at all. With a $5000 deposit, the interest paid would be $57.50 per year. Since inflation averages 2-4% each year, that $5000 investment will slowly lose its buying power as years go by.

I highly suggest that people learn how to invest in dividend stocks and open a self directed TFSA. Yes your money isn’t guaranteed like a savings account, but inflation is whittling away at your money anyway so why not take a chance and grow your money. I hardly knew anything about investing but I found a company worth investing in and I have almost doubled my money in 3 years. Every year I make over $800 in dividends tax free, which can be taken out at anytime but I keep it in there and reinvest the dividends to take advantage of compounding growth. Next year I hope to make over $1000 in dividends and the year after over $1300. Can you see why I like dividend investing so much?

Some of the Canadian banks have been paying dividends for over 100 years so they are one of your safest bets. I do not recommend holding US or other foreign stocks in your TFSA because you may be forced to pay a witholding tax. Keep good ole Canadian stocks in your self-directed TFSA and you won’t have to worry about paying any foreign taxes.

TFSA Qualified Investments. I almost went cross-eyed after reading the CRA website on what they consider is a qualified TFSA investment. If you are a glutton for punishment, you can read it here. Do not hold non-qualified or prohibited investments in a TFSA of they will be taxed.

Basically there is a huge list of investments that can be held in a TFSA under certain conditions which would need an entirely new post to cover all of them. You may also want you lawyer present to explain some of these conditions.

You can deposit cash and get a lousy interest rate. You can lock money away for years in a GIC and get a slightly less lousy interest rate. You can deposit bonds and get a “meh” kind of interest rate. You can hold mutual funds and make an investment manager very wealthy. You can invest in blue chip dividend stocks and get a healthy dividend yield that can grow over time and slowly make you rich, all the while earning you money, tax free. You can also buy and sell stocks and not be taxed on the gains as well.

TFSA and Income-Tested Benefits and Credits. A very important note about the TFSA is that the income generated in or withdrawn from a TFSA does not affect federal income-tested benefits and credits. So no matter how much money you make with a TFSA, it will not affect your Canada Child Tax Benefit, the GST credit, the Age Credit, Old Age Security and Guaranteed Income Supplement benefits. There are no age restrictions on the TFSA so you can keep contributing to it, even after you reach the age of 71. Unlike the RRSP, which forces you to convert it to a RIF.

TFSA And Death. When the holder of a TFSA passes away, it can be transferred to a spouse or common law partner that is designated the successor holder. The income remains in a TFSA and will continue to grow tax free, even if the receiving spouse/partner has no contribution room left. If no spouse or common law partner is left, the account is closed and the money is transferred to the estate of the deceased. Any income generated during this transition will be taxable with the estate.

Personal Thoughts on The TFSA

I can’t say enough about the TFSA. The ability to grow your savings without being taxed is an amazing opportunity. The TFSA rules and regulations can be changed at any time, but I highly doubt the federal government would ever scrap the program. Banks need the common folk to deposit their money. The TFSA gives greater incentive for people to deposit their money for longer periods of time. The more money people deposit, the more money the banks can loan out. The federal government wins on two levels by giving incentives for people to save for their future and stimulating the economy with banks loaning more money.

I choose to use my TFSA to save for my retirement. Right now there are 4 working people to every 1 retiree. When all of the baby boomers retire, there will be 4 retirees to every working person. There will not be a lot of government support when I choose to retire so I’m going to need all the help I can give myself in the future.

If I need to save for a car or a vacation, I will use a normal savings account. I won’t have to pay any taxes on the interest because, well, I’ll only be making pennies on my money. I hope everyone who reads this post has at least opened a TFSA because if you haven’t you are missing out.

Join me next time for round two when I dig deep and peel back the layers to discuss what the RRSP is all about.

How do you feel about the TFSA? Are you in a high interest savings account or a self-directed investing account?


This article was written by The Loonie Bin. If you enjoyed this article, please consider subscribing to his feed.

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