Young people today have a much different life and lifestyle compared to just a generation or two ago. They don’t follow the path their parents or grandparents may have taken which involved getting married, buying a house, having a couple of kids, and keeping a full time, permanent job often in the same line of work. In large urban centres these days, home ownership is often priced way out of reach, and today’s economy has resulted in fewer full time, permanent jobs. Other than some union and government positions, receiving a work pension is almost unheard of. The cost of living is high, and most young people struggle to pay rent, student loans, groceries and cell phone bills. With all of this in mind, it makes sense that saving for retirement might look a little different for a young person today – so where does someone start?
We know that a Registered Retirement Savings Plan (RRSP) is a trusted way for Canadians to save for retirement while they are in their working years and benefit from tax savings (i.e. tax refunds) until which time the money is accessed. RRSPs have a maximum amount that can be contributed to each year (18% of your gross income) and within an RRSP one can hold a multitude of investments such as stocks, mutual funds, GICs, bonds, etc. Over time, these locked-in investments will grow.
A Tax Free Savings Account (TFSA) is a fairly new type of investment account. Just like an RRSP, it’s designed to encourage Canadians to save money while offering some tax incentives, and there is a lot of flexibility to what types of investments can be held within a TFSA. However, unlike an RRSP there is no tax refund when we contribute to it, but we can withdraw from it at any time, tax-free. It’s not strictly geared towards retirement savings; a TFSA is simply a tax-sheltered account. Further, anyone over the age of 18 can contribute up to $5,500 per year towards a TFSA.
The RRSP vs TFSA showdown
Young people often ask if they should invest in either an RRSP or TFSA, but it’s important to consider the benefits and downsides of both:
Key benefits of RRSPs:
- Tax refunds are always nice for everyone, and for people with high earnings, it helps relieve those taxation blues until they are earning less (in retirement years).
- Penalties for withdrawing RRSPs are a good way to make it less accessible, so your money can grow untouched.
- Some employers offer contributions to match personal RRSP contributions.
Downsides of RRSPs:
- There are significant taxes to pay upon retirement age on all RRSPs drawn, just like regular income is taxed.
- There are significant penalties to pay if RRSPs are accessed before retirement age (with the exception of the Home Buyers Plan or the Lifelong Learning Plan).
Key benefits of TFSAs
- You don’t get taxed when you take from your TFSA (as you already invested in it with your ‘after tax’ earnings).
- It’s flexible! You can take money out and put more in (up to the annual maximum level) when it’s convenient with no penalties.
Downsides of TFSAs
- The actual interest earned on a TFSA is minimal unless it’s strategically invested.
- Its ‘flexibility’ can be a downside because it is very accessible and not locked in. Investments can’t accumulate if it keeps being ‘dipped into’.
Now for the hard part – picking just one
Any young person who commits to start saving now for retirement is very wise, regardless of which option they choose. Life gets busy, and something as far in the future as retirement may seem like an insignificant concern. The bottom line is that both RRSPs and TFSAs are excellent ways to pack that money away and watch it grow, and both have great options for how and where your money will be invested. Knowing your long-term personal and financial goals is important in choosing which one you’ll start with. For example, if you’re saving for a down payment on a home, that’s a very different goal than saving for retirement in 35 more years. Also, when annual earnings are very low for example, a TFSA may make more sense because there won’t be much of a tax refund anyway for buying RRSPs. If you are in a high income bracket however, an RRSP is a good idea. Ideally, it would be best to invest in both; having a TFSA as an emergency fund is always a good idea, and having the security of an RRSP goes a long way too. You may want to start small with both…but more importantly, start.
There’s a lot of information out there on how to invest your money, and frankly it can be overwhelming. The best advice is to be informed, and stay informed. Do your research and talk to an experienced financial advisor. To learn more about TFSAs, RRSPs or simply how to start planning for the future, connect with me by calling (705) 315-0516. I’m here to help you get saving.