The big question on many people’s minds going into 2021 will be whether to focus investing in an RRSP, or a TFSA account. Recent events have made the waters even murkier, with unforeseeable financial paths emerging as the world economy starts back up again. And start up, they have. While strategic lockdowns with specific criteria are popping up, most of the world is getting back to business, and that’s good news moving forward.
Deciding between an RRSP and a TFSA depends squarely on two things. First, your age bracket, and second, your long-term financial goals. Understanding both and applying each within a hypothetical financial scenario can help guesstimate which path to take.
RRSP accounts are designed primarily with retirement savings in mind; therefore we are dealing with a much longer term. By contrast, TFSA accounts are centered around traditional savings for certain things like a mortgage downpayment, or other expenses. Essentially, it’s the long road versus the short or medium one. Naturally, age plays a factor here. If you’ve been investing in RRSP accounts for years at this point, and are close to retirement, it would pay to continue doing so in order to round out that nest egg.
TFSA accounts depend heavily on your age bracket. If you’re married and in your early thirties, you might have already saved money in a TFSA to plan for the purchase of your first home. Conversely, perhaps you might wish to start saving money for your child’s post-secondary tuition fees. If you happen to be in your early twenties, you may wish to start putting money into a TFSA now, to get a jump start on where you want to be within the next decade. Remember that there are sometimes exceptions to this rule. For instance, the RRSP Home Buyers Plan is an option some may take advantage of.
It’s also wise to consider marginal tax rates when deciding which route to go. TFSAs hold an advantage if you happen to be in a lower tax bracket while contributing, and higher when withdrawing, whereas the opposite holds true with RRSPs. From a planning perspective, this makes sense. Those starting out on the rungs will probably find themselves in a lower tax bracket, which should rise as their career progresses, while those preparing for retirement are getting out of the field, completely. Even Stevens who stay within the same tax bracket up to the age of retirement should see little to no difference between RRSPs and TFSAs.
There are inherent risks to both routes, as well. TFSAs allow for early withdrawal, whereas RRSPs do not (at least not without uncomfortable penalties). This makes it easier for people to succumb to temptation and dip into TFSA savings for luxury items, or fear of an uncertain financial climate. RRSPs are effectively pushed far into the future as a set-it-and-forget-it means of savings, eliminating much of this temptation altogether.
A common practice is to start out with a TFSA before switching to an RRSP later on in life, which again is dependent on tax brackets. Those in a lower income bracket who suddenly find themselves jumping to a higher tier can transfer TFSA funds to an RRSP if they so choose, and contribute more to their retirement fund. Alternatively, if there’s more butter to spread around, they could use the TFSA for a luxury or home-related purchase, vacation or stock market/real estate investment, while still dedicating money to an RRSP on the side.
In fact, those who consider themselves financially inexperienced could opt for both a TFSA and an RRSP at the same time, provided they’re in a position to save. While there are some drawbacks to this approach, it is the best of both worlds, and can serve as a temporary solution that can be re-evaluated in favor of one or the other, as your career progresses.
With the global pandemic winding down, it’s time to choose how to save your money going into the new year. There are a number of factors to keep in mind, including the slight possibility of a second wave outbreak, as well as increased tensions with China, which will have an effect on world markets. Analyze where you sit on the financial spectrum, and if any of these criteria might possibly affect your income. Next, factor in the elements mentioned above, including both tax bracket and your age group, and the solution will become easier to obtain.
If you’re still uncertain, we’re here to help. That’s our purpose. Feel free to reach out to us for advice on whether a TFSA or an RRSP (or both) is a good option for you as we leave 2020 behind, and move forward. Hopefully the grass will be greener on the other side, and for years to come!