TFSA or RRSP: How to choose? – The Globe and Mail

As Canadian savings rates rise, a BMO report says older and wealthier Canadians are among those who should look at parking their money in a TFSA.

Piggy bank with coins iStockphoto

Happy New Year from our family "Down Under"

We’re back! I hope everyone had a great summer with a little bit of sun and fun. Of course, all good things must come to an end, and with children heading back to school (during the warmest week of the entire summer no less! Cruel, cruel nature.) I’ve been thinking about some of the things they end up learning outside the classroom. Many of the lessons that we learn in school don’t become relevant until long after graduation;  unfortunately some of these lessons can be very painful, and learning them the hard way can have a huge negative impact for many years into the future.

Before I attended my first class at the University of Alberta, I had a “free” travel mug (a gift for signing up for a new Visa), sports bag (Mastercard), and t-shirt (American Express). They handed these cards out like candy.

“You should start building a credit history,” was a popular line from the smiling, attractive sales reps. Not that I needed to be sold; I was an adult now! I could handle the responsibility! I had a weekend job, and not too many bills. What’s the harm?

Ever hear the analogy of giving a child a loaded gun?

“Big Cajun Man” wrote on his website “Canadian Personal Finance Blog” about having similar experiences:

Students: Banks’ New Markets

For those of you who are unaware, Banks try to capitalize on attracting new (and young) customers on campus these days (most Universities have entire bank branches on campus).  They are quite aggresive in their marketing to these new potential clients, enticing them with iPods and other “perks” to open new accounts.

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Banks are always on the look out to get NEW clients that want to pay Bank Fees and put their savings in their banks for the bank to use as well.  When you send your child/student off to school keep this in mind and maybe talk to your kids about banking and the in’s and out’s of the “Banking Game”.

Click here to read the rest of this article.

I’m a firm believer that the real education that takes place at college/university happens outside the classroom. Up to the point that they are sent off to school (or even well past that), most children have been totally dependent on their parents for housing, groceries, phone/tv/internet and other utilities, vehicle costs, maybe even allowance income. Even if they have been fortunate enough to have someone build an RESP for them, it’s still more money coming from “nowhere” that takes care of things for them. Some may have had part time jobs, learned a little bit about the value of money, but until you’re buying your own toothpaste…

“Big Cajun Man” says it well:

Teach Your Kids To Be Frugal At Back To School Time

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The point of University is to learn, and one of the things that kids need to learn is how to cultivate and develop their own Inner Frugality. If you buy your kids $3000 worth of furniture for their apartment, they are effectively living YOUR lifestyle (i.e. it’s just like home), whereas maybe they should be learning to live a frugal lifestyle instead? At University I had a treasure trove of old, used and scrounged furniture, and I loved it. No, my living room was not something out of “Better Homes” but it was mine (mostly my parents gave me an old dresser), and that is (I think) one of those things a kid in post secondary education (or one that has just moved out) needs, that sense of self.

Teach your kids to live within their own means, when they spread their wings and leave the nest, and that may be the most important thing they learn.

Click here to read the rest of the article.

To borrow another well-known phrase: “If you don’t talk to your kids about money… someone else will.”

You can hit a nail with a monkey wrench, but that doesn’t mean it’s the best tool for the job.

There has been some excellent discussion of the new Tax-Free Savings Accounts (TFSAs) and how they compare to Registered Retirement Savings Plans (RRSPs), in particular relation to retirement income and tax efficiency (i.e.: in which account do you end up saving more).  The simple answer is that it depends on what your tax rate is when you are putting money into the accounts versus your rate when you are taking it out in retirement.

However, I don’t think this is the right, or at least the only, way to look at these two options.  Like the monkey wrench analogy above, the TFSA and the RRSP are two different tools, not designed or intended to do the same job.  I recommend you seriously consider using both for the jobs for which they are built.

RRSP = Retirement

TFSA = Savings

The TFSA is a savings account.  Yes, you can use it to save for retirement, but you can also use it to save for a house, for a car, or my personal favourite: for that unforeseen emergency that usually ends up on our credit cards or taking a chuck out of our RRSPs.

So how should you use your TFSA?  If you regularly max out your RRSP and still have money left to invest, then it’s a ‘no-brainer’.  Even if you are unable or choose not to use all your RRSP contribution room, the TFSA is a very smart choice to put (or start building) your 3-month emergency fund, savings for your children’s education (beyond the optimal RESP maximum), or any other financial goal more than one year in the future.

There are a number of downsides if you ever choose to take money out of your RRSP before retirement.  Chief amoung them is the tax hit (your withdrawal is considered income), or at best you are locked in to a repayment schedule (as with the Home Buyer’s Plan).  Neither of these apply to withdrawals from your TFSA, which makes it a far more efficient and flexible choice for any pre-retirement financial goals/needs.

To get your TFSA started quickly, there are a few easy strategies you could consider:

• Move your current emergency fund into a TFSA ($5,000 maximum this year).
• If you make bulk annual deposits into your RRSP, put 10-15% into a TFSA.
• Deposit your tax return in a TFSA.
• Start a $25/month automatic deposit.

My first recommendation to most people is to always have that 3-month (minimum) emergency fund in safe, liquid investments (such as a high-interest savings account, GIC, or bond/money-market fund).  You want that money to be there if/when you need it.  Beyond that, it is worth having a conversation with your advisor to help you determine an appropriate portfolio for your time horizon and risk tolerance.  If it would help you keep your goals straight, you may even want to consider opening two different TFSA accounts; one for your emergency fund and the other for your savings (new home, renovations, car, big vacation, wedding, etc.)!  Remember, you can still only contribute a maximum of $5,000 combined for the year (unused room does carry over).

Retirement planning with your TFSA is worth a article on it’s own, but suffice to say that the closer you get to retirement, the more you want to have built up in your TFSA.  One big reason: income-tested benefits and clawback.

The Tax-Free Savings Account is an excellent tool for all of us to add to our financial plan.  To quote one of my favourite movies that was on TV over the weekend: “Would you like to know more?”

Pick the right tool for the job, and you'll be all smiles!

Photo credit: “Out of line” by j / f / photos and “The Astronaut Twins” by oskay