The CD Howe Institute has released an interesting review of RRSPs versus TSFAs. Alexandre Laurin and Finn Poschmann have written Saver’s Choice: Comparing the Marginal Effective Tax Burdens on RRSPs and TFSAs.
Everyone in Canada gets sold on the idea of putting money into an RRSP, but is that really the best option for people? A Registered Retirement Savings Plan is really a tax deferral system, the assumption is that your income taxes on the money now is more than what you would pay when you withdraw your money. The tax savings when you are young or in a low income year is not that much.
A Tax Free Savings Account is funded with income you have paid tax on but the savings are then never taxed again. You can access the money whenever you want and not have to pay any taxes on it.
If you have a split between RRSPs and TSFAs, when you get to retirement age only the income coming from the RRSP is taxable. You could use the TSFA to effectively reduce your taxable income in retirement dramatically.
All in all I am very happy that the government created the TSFAs because it gives people more cost effective options for saving money. It is in the interests of the country to have a much higher savings rates but savings have been penalized through taxation when the money was earned and then any interest or capital gains from the savings, the money was taxed twice.
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I also believe the TFSA was designed to replace the promise of being able to defer capital gains income for up to 6 months if the gains were re-invested.
In the first few years of the program the $5,000 contribution limits will not be too material, but looking down 10 or 20 years it will be - especially for those that can compound these gains early in the cycle. Also whenever interest rates increase this will provide a risk-free tax buffer for people with ordinary savings.
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