Millennials have been dealt a tough hand.
Heavy student debt, sky-high housing prices, and promiscuous work are among the plethora of reasons why millennials are having a tougher time than their baby boomer parents did when they were younger. While the financial outlook for millennials may seem bleak, it’s actually peachier than it appears on the surface, given that millennials have the ability to get many decades’ worth of tax-free compounding through an investment vehicle like a TFSA or RRSP.
Sure, other generational cohorts also have access to these tax-free investment vehicles, but unlike millennials, the boomers won’t have as many decades of tax-free compounding as their millennial children. To put it simply, a TFSA or RRSP is a powerful tool that amplifies the long-term wealth creation.
If you’re a millennial who’s recently gotten out of debt and are looking to start contributing to a registered account, one of the most common questions is whether it’s a better idea to invest in a TFSA, an RRSP, or both. Your advisor is likely to tell you to contribute to both, but if you’re well under the cumulative TFSA contribution total of $57,500, then it might be favourable to opt for one registered account and not the other.
The million-dollar question: TFSA or RRSP?
Many millennials I’ve spoken to aren’t big fans of the RRSP, as there are rather complicated restrictions tied into the vehicle that aren’t present with a TFSA.
RRSPs allow for tax-deductible contributions, but tax-free withdrawals are out of the question, unless you want to be slapped with a bill from the tax man. The reverse is true for a TFSA, whereby proceeds are contributed on an after-tax basis with tax-free withdrawals being allowed without any tax complications. If you overcontribute to a TFSA, however, be prepared for the tax man to unleash his fire and fury upon your savings!
The biggest takeaway is that an RRSP is meant for traditional retirement only, as it lets you defer your taxes at a future rate which is likely to be lower, unless your non-registered dividend income swells in size. Given the barrage of contingent expenses that may arise between your retirement date, however, the RRSP’s artificial barrier on premature withdrawals is a major turn-off for millennials when compared side by side to a TFSA.
The TFSA can also be used as a retirement account, but with less strings attached, and it can also serve as an emergency fund, as it allows you to withdraw without getting penalized when you’re already in a tough spot.
Moreover, given the rise in popularity of the FIRE (financially independent, retire early) movement, you’re going to have to convince the tax man that you’re actually retired at 40 to withdraw from your RRSP without penalty. Add the fact that today’s young people are likely to move to a higher tax bracket in the future, and that they could take a hit to the chin if they need to withdraw before they expect to retire.
And the winner is…
So, for millennials, the TFSA is the clear winner. It’s an all-purpose account with fewer strings attached and less commitment, worry about future contingent expenses, or future tax brackets. It’s the lower-risk option given the uncertainties of the distant future!
If you’re under the $57,500 limit for the TFSA, I’d contribute to it in full and take a pass on the RRSP, a vehicle that I don’t believe is convenient nor ideal for most of today’s young people. BMO Low Volatility CAD Equity ETF (TSX:ZLB) is a great place to start if you’re looking for a one-stop-shop solution that’s also insulated from excessive amounts of volatility.
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Fool contributor Joey Frenette owns shares of BMO Low Volatility CAD Equity ETF.