Unlike the RRSP and RPP, the TFSA can be used for either short or long-term saving, so a TFSA can be a great tool to save for down payments, vacations, or weddings. If you invest for the long term, you'll reap the benefits of long-term growth and additional compound interest and reinvested returns.
Whatever your goals, the best way to utilize a TFSA is to maximize the allowable yearly contribution. This strategy, like any other type of investment plan, means there'll be more opportunity to earn through compound interest and reinvested returns.
Non-Registered Investment Plans
Non-registered investment plans have fewer tax advantages. Returns generated within a non-registered plan do benefit from a dividend tax credit and a favourable capital gains tax rate (laws and regulations on taxes can change so it's important you research and review your current tax situation with a tax accountant). They are, in many cases, accounts for independent investments that don't fall within an RRSP, RPP, or TFSA. Non-registered plans come in very handy when you don't want to contribute to an RRSP or TFSA, maybe because you've maxed out your contribution limits. Prior to 2009, the TFSA wasn't available so many people saved in non-registered plans as well as in RRSPs. A non-registered plan also can be used to house non-eligible RRSP investments (this would be disclosed on the investment itself or the program it's associated with).
Sometimes employers have independent non-registered savings programs such as profit sharing or a share purchase plan that employees can use in addition to their rpp; if the employer contributes to it as well, it becomes a taxable benefit and you'll have to pay tax on the money contributed by your employer. Still, it's almost free money!
The RRSP versus the TFSA versus Non-Registered Plans
The primary difference between RRSPs (and RPPS), TFSAs, and non-registered investment plans is in the ways you're taxed. The following example illustrates the point.
If you invest $5,000 in a mutual or index fund that generates returns each year, in each of the plans, and allow for all returns to be reinvested and compound at 8.5 per cent annually for twenty-five years, your net proceeds from the RRSP is greatest, followed by the tfsa. But you don't earn nearly as much with a non-registered plan primarily because you're taxed yearly on those earnings. (This example uses an investment income tax rate of 28 per cent. Laws and regulations on taxes can change so it's important you research and review your current tax situation with a tax accountant.)
Wondering what's best for you? Based on this mutual/index fund example, the RRSP (and rpp) allows you to get a head start on earning more potential returns because the sum invested is larger. The TFSA earns less return upfront, but pays less tax in the future. The non-registered plan ensures you pay taxes throughout the course of the plan, which really eats into the amount of money you're able to earn and build. There are still benefits to investing in a non-registered plan, but the tax incentives in the TFSA and RRSP are generally more favourable.
With this example, there's one more thing to be aware of: you may not know the tax rate at the time of withdrawal compared to when you contributed.
Since your RRSP limit (18 per cent of your income) will likely be much higher than that of the tfsa ($5,000 and indexed into the future), you'll be able to save the most in an RRSP each year, which earns you more in compound interest and reinvested returns. Additionally, your tax rate upon withdrawal could be lower as you'll be retired.
Your first priority should be to maximize your RRSP contribution room. Second, maximize your tfsa room. Third, contribute any additional savings into a non-registered plan. If you can't max your RRSP limit and still want to contribute to the TFSA, use a hybrid approach-I'd recommend two-thirds RRSP and one-third TFSA. A hybrid approach works well because your tax deduction in the RRSP is greater because you're contributing more plus you get to grow your money tax-free in the tfsa. It's like having the best of both worlds.
From Rich by 40 Copyright © 2010 by Lesley Scorgie. Published by arrangement with Key Porter Books.