The Registered Retirement Savings Plan (RRSP) and the Tax-Free Savings Account (TFSA) are amazing tools that Canadians can use to maximize wealth for retirement. However, there is some debate as to which account is better to utilize first.
Frankly, Canadians should be using both. They each have unique attributes that can contribute to both preserving and growing your wealth all the way to retirement. Here’s why.
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The TFSA: The easiest registered account to use
The TFSA is the easiest account to comprehend. All investment income earned inside the account is tax-free. Likewise, when you withdraw capital from the account, there is no tax liability. Canadians who were born in 1991 or earlier should have available contribution room of $109,000 in accumulated TFSA space.
There are a few simple rules to follow with the TFSA, but it is certainly the cleanest and most straightforward account to invest in. The TFSA is a great place for targeting your largest growth investments.
A perfect TFSA investment
If you have a stock that has multiplied by 10, 20 or 50 times, you don’t want to pay any tax on that significant gain. A stock like Aritzia (TSX: ATZ) would be a good candidate for a TFSA.
Aritzia has delivered significant returns for shareholders. It is up 519% in the past three years. Its “Everyday Luxury” brands are resounding, particularly in the U.S. where it is enjoying dramatic growth.
The company exceeded its five-year growth targets a year earlier than planned. It continues to aim to double again in the coming five years.
With a huge market to grow into, the future still looks optimistic. The one detraction is this stock can be volatile. A negative-20% drop in any year is considered normal. Buy and hold it long term in a TFSA, but be ready for a rollercoaster of a ride.
RRSP: The tax deductions and tax-free growth can be very valuable
The RRSP is a little more complicated. When you contribute to the account, you get a tax deduction for the same amount in that calendar year. If you are in your peak earnings years, you can use RRSP contributions to reduce your taxable income. That can be enough to push your taxable income to a lower tax bracket and save you substantial taxes.
The RRSP can be a serious tax reduction weapon if you make a big specific gain in any one year, or if you want a big tax refund at the end of the year.
All investment income inside the RRSP is tax-free while the capital stays in the account. However, the catch comes when you withdraw. If you withdraw, that withdrawal will be treated like taxable income and you will be taxed at your marginal tax rate.
The point is to wait until retirement to withdraw because your income and tax rate will be lower. Given the RRSP’s focus on holding until retirement, I would focus my investments on lower-risk, steady investments.
A solid stock for retirement
Fortis (TSX: FTS) is a perfect stock to hold in an RRSP. Over the past 10 years, it has delivered an 11.5% compounded annual total return.
Fortis operates an easy-to-understand regulated utility business across North America. It is focused on distribution and transmission assets that are near 100% regulated.
It just increased its five-year capital plan and raised its rate base growth estimates to 7.5% per year. It also raised its dividend for the 53rd consecutive year.
For a mix of stable growth, income, and low volatility, Fortis is the perfect stock to hold in an RRSP all the way to retirement.
