If you’ve read some of my other posts about money, found here and here, I’ve explained how 2016 is the year I turn things around. I used to be really bad with my spending, I didn’t understand much about personal finance, and I never really new what this ignorance was costing me.
So, after a few panicked life episodes where I feared for my financial future, I read a few books and completely overhauled my finances.
I’ll write about what I did as simply and as hilariously as I can, but it’s important to do your own reading so that you make decisions that are best for your situation. I am not a financial advisor, nor am I very smart.
This post is about the difference between a TFSA and and RRSP, and which I prefer. This is a great place to start for the average Canadian interested in Stacking Mad Bordens. The TFSA and RRSP are the two greatest tax-dodging, wealth building mechanisms available to Canadians, and we should all have one of each.
Much of what I have learned on this topic comes from the writing of Gordon Pape. This nice man.
An RRSP is like a bucket. You can fill it with money. It’s not an investment, just a bucket. However, for every dollar you contribute to an RRSP, your taxable income is reduced by a dollar. If you make $55 000 a year, you will pay about $14 300 of that to the tax man. But if you make $55 000 and contribute $5000 of that to an RRSP, you will only pay tax on $50 000, meaning a tax bill of $13 000. Not bad, right? And you still have that $5000, it’s just waiting in your RRSP account until you need it. The day will come, however, when you retire and want that $5000. It is a Registered Retirement Savings Plan after all. However, because you are likely to have a smaller income when you retire, that $5000 will be taxed at lower rate than when you are working. You can’t avoid the tax man, but you can hold him at bay. For a while.
A TFSA doesn’t hold the income tax man at bay initially. Contributing to a Tax Free Savings Account will not reduce your taxable income. If you make $55 000 and contribute $5000 to a TFSA, you will still be taxed on the $55 000. So what’s the point?
The POINT is that the TFSA, just like an RRSP, is also just a bucket. It holds things. If you put money in it, it holds money. If that money accrues interest, then you can spend that interest without ever paying tax on it, or the principle. That’s not true for any other banking product, registered or non-registered (not a TFSA or RRSP). In every other situation outside of a TFSA, you would have to claim the additional income on your taxes.
From this description, it would seem like the RRSP might be the winner, but I don’t think so. Because the TFSA and RRSP are just buckets, you can put things in them other than money. These buckets can hold your INVESTMENT portfolios.
Here’s where the TFSA wins in my books. If you hold your investment portfolio in a TFSA, you can MAKE A KILLING in the stock market and pay no tax on that money at all. EVER.
For example, if I contribute $458 a month to a TFSA (the maximum amount allowable. There’s a $5500 a year cap) that holds investments with an average annual rate of return of 6%, I will have invested $55 000 after ten years, but my TFSA will be worth $76,844.03. At 25 years I’ll have contributed $137 500, but my TFSA will be holding $319,860.10.
Funds in an RRSP can also be invested at the same rate of return, but you would owe a good chunk of that money to this guy, who can, quite frankly, afford his own sweaters. If you max out your contributions to your TFSA, then start thinking about the RRSP.
I’ll get into details on exactly where and how I have invested my money in a future post (it’s just index funds, nothing exciting) but the Canadian reader would benefit greatly from checking out The Value of Simple from their library, in which Dr. John Robertson spells out exactly how to open an investment account for every major (and some not so major) bank in the country.
Fill your buckets. Stack some Bordens.