When should you use a TFSA?
TFSAs are more flexible than RRSPs, so they tend to be better for younger Canadians and short-term saving, such as when you're saving up to buy a house, or a car. But in some cases, they can also be a better choice for retirement savings too.
For instance, many advisers recommend TFSAs as a retirement savings vehicle for savers who have a lower marginal tax rate. As a general rule, says Marc Lamontagne, a fee-only adviser with Ryan Lamontagne in Ottawa, if you're making less than $41,000 a year, you'll likely come out ahead over the long run with a TFSA. The best part is that when you take the money out in retirement, it doesn't count as income, so you don't have to worry about clawbacks to government retirement benefits, such as Old Age Security (OAS) or the Guaranteed Income Supplement (GIS).
Let's look at the fictional example of Molly Reynolds, a 30-year-old child care worker in Ontario, to illustrate. In order to build up a nest egg for retirement, Reynolds wants to save $5,000 a year until she reaches age 65. She makes $35,000 a year, so she is in the 20% tax bracket while contributing. Should she use a TFSA or an RRSP? Because she's in a lower tax bracket during the years she contributes, she would come out ahead with a TFSA. If we assume a 6% annual return on her investments, her nest egg would be worth $395,290 after taxes if she uses a TFSA versus $383,270 in an RRSP (if she reinvests her RRSP tax refund each year). So she'll be $12,000 ahead with a TFSA.
TFSAs also make great sense for those who have a good defined benefit pension plan at work, no matter how much they make. "In this case, it's almost always best to contribute to a TFSA instead of an RRSP," says Al Feth, a fee-only adviser in Waterloo, Ont. "Mandatory withdrawals required by RRSPs at age 72 could boost you into a higher tax bracket and result in clawbacks to your Canada Pension Plan (CPP) and OAS -payments in retirement. You won't have that problem with TFSAs because when you take money out during retirement, you will never be taxed."
Finally, if you're a high-income earner and you expect to max out your RRSP contribution limits, a TFSA makes a great second savings vehicle.