I was sitting around earlier thinking about different ways you can use a TFSA and RSPs. In doing so it occured to me that when the Canadian government set up the TFSA they may have unintentionally changed the face of the savings account game a bit.
First of all let’s review the difference briefly:
- TFSA – you pay income tax on money you put in but not on money you don’t
- RSP – you don’t pay income tax on money you put in but you do when you take it out
And of course the similarity between the two being that you don’t pay income tax on whatever gains you make while it’s in the account.
So basically to me this means [I'm not going to do any math here but feel free to verify and comment if you find otherwise]:
- Early in life when your income is low and your tax bracket is too you should contribute as much as possible to a TFSA since you theoretically will be paying more taxes when you retire (you pay first but less taxes)
- Later in life, but before retirement, your tax bracket is likely to be higher then when you retire so you should contribute to an RSP since you’ll be paying less taxes when you retire
Now the tricky thing is in the middle at some point there will likely be once you’ve transitioned from the stage where you are better with an RSP then a TFSA. What could you do with the unused TFSA contribution space?
Well, I was thinking that what if you just used it as your regular savings? This means that money you were saving up for a down payment on a new car, or maybe that big vaction next year could be kept in a no interest account until you actually need it. What a novel idea, for the average person who never actually reaches their full contribution on their RSP and now TFSA why wouldn’t this work?
And for that matter maybe at some point in the middle (and I don’t know the accounting part of it) you could actually take money out of your TFSA put it into your RSP and get the income taxes back on it. Sneaky, huh?