The debate has been around for as long as the TFSA has existed. Which tax-deferred account should get top priority?
TFSA supporters like the account’s flexibility, which allows investors to withdraw money whenever they’d like without paying a nickel of tax, rather than RRSPs, which have an automatic withholding tax penalty on early withdrawals.
TFSAs are also more easily maxed out by the average saver. The $5,500 annual limit is more manageable than RRSPs, which are 18% of an employee’s income up to a maximum of $26,000. Somebody making just $31,000 will have more RRSP room than TFSA room.
But RRSPs have their own advantages. A big one is the tax refund an investor gets when contributing. Say somebody is in the 30% tax bracket. A $10,000 RRSP contribution will result in an immediate $3,000 tax refund.
If someone then reinvests that tax refund, they’ve really supercharged the amount of capital available for investing. It’s an easy way to end up with more cash come retirement time, when it really counts. That $3,000 could be worth several times that after growing tax-deferred for a few decades.
Ultimately, it comes down to somebody’s tax bracket. High earners will get far more out of the RRSP than people just starting out their career. It makes sense for people earning a lot to max out their RRSPs. People who don’t earn much today but expect to earn more later should save the contribution room for later and focus on TFSAs.
