TFSA or RRSP: Where Should You Put Your Money?

Being a busy mom with a one year old toddler and a small business owner, it isn’t exactly easy to find time to read.

Audible has actually become my best friend over the last few years. (For those of you who don’t know, Audible is owned by Amazon that offers audio books for a monthly subscription fee.) I highly recommend it to everyone who has to take a long commute to work everyday.

There is no better way to spend the hour commute filling it with interesting content.

Recently, I have been listening to Tony Robbins, “Money: Master the Game”. Despite the lack of Canadian content, it does provide some good insights in today’s investing market.

One thing that I picked up is that he favoured to pay the tax now and invest in Roth 401K, the US version of Tax Free Saving Account (TFSA), instead of deferring the tax till you retire by investing in 401K, the US version of Registered Retirement Saving Account (RRSP).

His philosophy is that US debt has skyrocketed over the last decade, the only way the US government is able to repay it is to raise taxes. He believes that tax rate will only go up, not going down. Hence, it’s better to pay the tax now, put the after tax money in a TFSA account and grow your wealth in it tax-free.

Interesting, isn’t it?

It is an especially interesting concept to me given that we, as accountants, are educated to advise our clients to put their money in RRSP to defer taxes.

If you are currently paying the highest marginal tax rate, and you are not expecting to have any less income when you retire, and continue to pay the exact same rate 20 years from now, mathematically, whether you invest in TFSA or RRSP, your after tax dollar is the same.

Say you are contributing $5,000 every year to your TFSA annually and you are at the highest marginal tax rate, every year you are earning 10% return and you reinvest all the money you get back (compounding every year), 20 years from now, you would have accumulated $315K in your TFSA account.

Of course, this is all tax free. You can continue to invest or you can take out the money.

Now, say instead of contributing to TFSA, you contribute the equivalent amount before tax to your RRSP. If your top marginal rate is 50%, the equivalent amount before tax is $10,000. You put the same amount every year in your RRSP for 20 years earning 10% return and you reinvest all the money you earn to gain the same return, at the end of 20 years, you have $630K available for you to withdraw.

Twenty years from now, if you are being taxed at the same rate as you have been for these twenty years, i.e. 50% in our example, your after tax money available from your RRSP account is exactly the same as your TFSA account, $315K ($630K * 50%). Pure mathematics.

However, if you are paying slightly less tax, even at 40%, your net after tax cash from RRSP account would have already been higher than the TFSA account.

On the flip side, if you believe that tax rate will rise in the future, even more than 50% (just feeling sick thinking about higher than 50% tax rate), TFSA is definitely your choice.

Maybe you are just starting your career, you are still young and you are expecting to make a lot more in the future than today (the same scenario as rising tax rate), it’s definitely worth while taking advantage of TFSA as well.

And of course, if you have sufficient financial resource, why not take advantage of both investment opportunities? Both are great saving vehicles that allow you to shelter a portion of the income in a tax-free environment.

As real estate investors, you probably would ask me this next – “how can I invest in real estate using the money in my registered account (RRSP, RESP, IPP, PPP and TFSA)?” I will attempt to answer this question in my next blog post.

Stay warm and have a great weekend,

Cherry Chan, Real Estate Accountant