Posted on Friday January 11, 2019

RRSP or TFSA: Which Should You Choose While You're Young?

When you're young, you have endless plans for the future. Finishing school, launching a business, buying a vehicle, starting a family, purchasing your first home, travelling abroad? As a result, saving for the future, much less for retirement, may often fall to second (or last!) place on your list of priorities. Here's what you need to know about the two main savings tools: the RRSP (and Home Buyers? Plan) and the TFSA.

RRSP: Ideal for saving money tax-free

The RRSP (registered retirement savings plan) is an account registered with the federal government that any Canadian citizen (you must have a social insurance number) can use to build up savings. The money deposited to this account and any interest earned are invested by the financial institution holding the account to generate income that can be withdrawn later following retirement.

Saving for retirement through an RRSP:

• Contributions are tax-deductible (subject to certain limits). The amount you deposit to your RRSP is therefore subtracted from your total income before calculating the income tax payable.
• Any interest earned in your RRSP is also tax-sheltered until you withdraw it, which helps your savings grow.
• You can contribute up to 18% of your income (subject to an annual ceiling) to your RRSP, which reduces the amount of income tax you have to pay (which can be very significant especially if the deduction drops you into a lower tax bracket).
• Funds held in an RRSP are taxable only at the time of withdrawal. The tax savings are therefore substantial if you withdraw from an RRSP when your income (and consequently your marginal tax rate) are lower, which is usually the case after retirement.
• Contribution room grows over time. In other words, if you did not make the maximum contribution in a given year, you can make use of the remaining room in a later year without penalty.
• It's also possible to contribute to your spouse's RRSP while benefiting from certain tax advantages yourself.
• The deadline for contributing to an RRSP for any tax year is January 1, but you have up to 60 days after that date to do so, or until March 1, 2019, for the year 2018.
• Minimum age to contribute: as soon as you begin earning income. Maximum age to contribute: 71.
• Under the Home Buyers? Plan (HBP), you can withdraw funds from your RRSP without penalty to put toward the purchase of your first home (or if you have not owned a home in the last five years).

Through an RRSP, you have a range of investment options, from highly speculative to fixed-income securities or guaranteed investment certificates (GICs) depending on your risk tolerance. You can also invest in mutual funds through your financial institution. If you prefer to maintain greater control, a self-directed RRSP allows you to make the investment decisions yourself.

New Brunswick: Lagging behind when it comes to saving

Based on a Statistics Canada study, approximately one-quarter of households in New Brunswick contribute to RRSPs, the lowest proportion across Canada. TFSAs (tax-free savings accounts) are also less widely used in New Brunswick than elsewhere across the country. By starting a savings plan early, you will not only be setting yourself up for a more comfortable retirement but also potentially making it easier to buy a home under the HBP. According to a study published by the Atlantic Institute for Market Studies in 2017, the three most affordable urban markets across Canada are all located in New Brunswick: Moncton, Saint John and Fredericton. The New Brunswick government also has its own initiative in place called the Home Ownership Program.

Time is your best friend

The RRSP is an investment tool that becomes even more valuable over time, since you benefit from its tax advantages both at the time of contributing and all life long. The earlier you start contributing, the longer your capital can grow tax-free. The following table illustrates the advantages of contributing early. 

As you can see, someone who sets aside a total of $45,000 (at a rate of $1,500 per year) beginning at age 25 enjoys much greater return on his or her investment than someone who sets aside exactly the same amount of money but beginning only at age 45 (at $3,000 per year).

RRSPs and the HBP: Getting your foot in the door of your first home

Contributing regularly to an RRSP is an excellent way to save toward a down payment on a house since the Canada Revenue Agency established the Home Buyers? Plan (HBP). What you need to know:

• The HBP is available to buyers who have not owned a home in the last five years.
• Under the HBP, buyers can withdraw up to $25,000 from their RRSP to put toward a down payment without tax penalty.
• If you're married or living common-law, this total may be up to $50,000.
• The home purchased or built must become the primary residence of the owners by October 1 of the year following the year in which the funds were withdrawn from the RRSP. (If building new, be sure to take construction delays into account!)
• The funds must have been deposited to the RRSP at least 90 days prior to the withdrawal date.
• You can then take up to 15 years to repay the money into your RRSP at a rate of 1/15 per year. (Example: if you withdraw $30,000, you need to repay $2,000 per year.)
• The first repayment must be made by December 31 of the second year following the withdrawal.

The program consequently helps provide first-time buyers access to funds for a substantially larger down payment without any tax penalty. This makes regular RRSP contributions an excellent way to build up funds for this purpose. Meet with a UNI representative for additional information or download the HBP application form.

Borrowing toward a contribution to maximize tax benefits

Have your eye on a home but don't necessarily have the funds for RRSP contributions in order to take advantage of the HBP? Borrowing may be an option so that you can make the maximum annual contribution and reap all the tax benefits that an RRSP offers. In households where one spouse's income is significantly higher than the other's, another option is for one spouse to contribute to the RRSP of the other while still benefiting from the tax deduction.

The TFSA: Earning interest tax-free

The TFSA is an important tool for building wealth over the long term. All funds you deposit to a TFSA are tax-free. Any long-term investment strategy should consequently include a TFSA due to its major flexibility.

What you need to know about the TFSA:

• It allows you to set aside a portion of your income to earn interest tax-sheltered.
• The annual contribution deadline is December 31.
• You can make withdrawals without any tax penalty.
• Minimum age to contribute: 19. Maximum age to contribute: None.
• You cannot contribute to a spouse's TFSA.
• Contribution room grows over time. In 2019, the annual contribution is $ 6,000, and an adult who does not yet have a TFSA can contribute up to $ 63,500 for the same year. 
• Withdrawals have no impact on any other pension plans.
• The amount of any funds you withdraw goes back into your contribution room.
• Contributions are NOT tax-deductible.

The TFSA's flexibility makes it an excellent savings tool when you are young. You can withdraw funds to put toward special projects (buying a home or car, starting up a business, taking a trip, etc.) without losing the benefits of tax-sheltered savings. If you're saving specifically toward a down payment on a property, you're better off contributing to an RRSP rather than a TFSA due to the RRSP's tax advantages... and the HBP.

Thanks to the HBP, the RRSP remains the ideal tool for saving toward a down payment on a first home. If you're aiming for a short-term goal instead, the TFSA's flexibility makes it a highly useful tool. Any long-term strategy targeting financial independence should likely incorporate both of these tools. Happy RRSP season and here's to building up your savings in 2019!