TFSA or RRSP: How to choose?

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Older and wealthier Canadians, as well as students and young couples without children, are among those who should look at parking their money in a Tax-Free Savings Account (TFSA), says a report released Wednesday.

Since the birth of the TSFA on Jan. 1, Canadians who can't afford both have been struggling to choose between a TFSA or Canada's long-standing tax shelter savings product, the registered retirement savings plan (RRSP).

A report from BMO Capital Markets pinpointed some groups of people for whom the new TFSA "should be a more attractive investment option" than an RRSP: Younger Canadians, including students and the working but childless, who are in a low-income stage of their life and have excess cash after paying down their bills and drawing down debt. Another is affluent people, who have money to save after maxing out their RRSP contribution and can use the TSFA to supplement their retirement savings.

The BMO report found that of those groups, "TFSA contributors tend to be older and more affluent, suggesting younger people are using whatever savings they have to first pay down debt."

By all accounts, the TFSA has proven to be enormously popular with Canadians. Between Jan. 1 and the end of June, about 3.6 million people set up a TFSA, stockpiling $12.4-billion, according to data from Toronto-based financial research firm Investor Economics and pollster Ipsos Reid.

. Weigh in on whether you would stash some extra money into an RRSP, RESP or a TFSA.

Part of the popularity of the TFSA can be attribute to timing. It arrived at a time when a global economic recession had for the first time in years led people to curb their spending and store away some of that money.

On average, Canadians are now saving 4.8 per cent of their personal income, compared to an average rate of only 3.7 per cent in 2008 and 3.8 per cent over the first five years of this decade when the economy was booming, the BMO report said.

"Canadian savings rates have increased as a direct result of great concern, more frugality, and a certain level of uncertainty about the outlook...," said BMO chief economist Sherry Cooper. "Of course, people who have suffered unemployment will not be opening TFSAs because they are living off their savings. But on the whole, people are recognizing that the only way to rebuild their savings is to spend less than they earn."

Because people fear spending money during periods of economic turmoil, she expects Canadian savings rates may edge even higher from their current rate.

TFSAs allow people to save or invest $5,000 a year for any purpose - retirement, education or a rainy-day fund - without paying tax on investment or capital gains when the money is withdraw at any time down the road. You can carry forward unused contribution room for future use and you can use your TFSA to invest in savings, GICs, mutual funds, stocks and bonds.

The beauty of the TFSA, financial experts say, is that it gives people flexibility in terms of how to use their money.

For instance, the BMO report noted that under the Home Buyers' Plan, first-timers can tap into their RRSP assets to help come up with the necessary down payment. But now first-time home buyers can also turn to their TFSA, which offers them more flexibility in terms of replenishing the depleted asset.

"Under the Home Buyers' Plan, the plan holder is required to re-contribute to the RRSP over a period of 15 years, whereas for the TFSA no repayment is required and the amount of the withdrawal is added to future TFSA contribution room," BMO said, adding that funds from a TFSA can also be use for renovations or other home improvements.

TFSAs can also help retirees by providing them with additional opportunity to shelter income after they turn 71, the BMO report said, by allowing them to put money into a TSFA after they are no longer eligible to contribute to an RRSP. "In addition, if retirees are required to take more income than they need from a RIF, they can contribute to a TFSA out of the excess and thus continue to shelter investment earnings from tax," the report said.