In the past we have compared RRSP and TFSA accounts, and RESP vs RRSP accounts, so today we’re going to do a head-to-head comparison of TFSA vs RESP contributions. For those of you that aren’t aware of what all of these acronyms mean, a Tax Free Savings Account (TFSA) is a savings vehicle that only started a few years ago as an alternative to the traditional Registered Retirement Savings Plan (RRSP). The Registered Education Savings Plan (RESP) is an account that parents can set up to efficiently save for their children’s education. All three of these plans are registered, and all three allow your investment dollars to compound while being sheltered from taxation as long as they are in their respective plans. There are some key differences however.
The TFSA vs RESP argument is a little easier to digest than the others because both plans use after-tax income. This means that unlike their RRSP brethren, you would invest in either type of account/plan with money you have already paid taxes on (the RRSP of course includes a tax deduction at your marginal tax rate; therefore, using pre-tax income). The differences come in what incentives the government will give you to use in each plan, as well as how taxation is handled when money is removed from either account.
The great advantage that RESP contributions have over TFSA contributions is that the government will give you up to $500 (that can then be invested for further compounding) in the form of a Canadian Education Savings Grant (CESG). The CESG is an automatic 20% match of your RESP contribution, up to $500 per year, and/or $7,200 lifetime. That automatic 20% ROI is tough to beat, and it is the reason that I think underutilizing your RESP is a major error if you have children. In this information age, encouraging your children to take some form of post-secondary education (it definitely does NOT have to be university) is only common sense. Helping them realize their educational goals is one of the greatest gifts a parent can give their child in my opinion.
While the RESP has a great advantage with its CESG contributions, the TFSA does shine in a couple of other areas – simplicity, and taxation. One of the most appealing attributes about a Tax Free Savings Account is the fact that money can be withdrawn at any time without any penalty or even much paperwork. Contributions can be made in a similar fashion. In fact, if you want to trade stocks or other investments inside your TFSA it’s a very easy process to simply open an account with a discount brokerage such as Questrade and go from there. RESPs usually require a little more paperwork, and planning. Also, there are some complications with the money inside of an RESP if it is not used by your child. While all of your original contributions, plus the investment returns on that money (forfeiting the CESG money, and the investment returns from it) can be moved into your RRSP without major penalty, pure simplicity is still a major consideration for most people. When it comes to robo advisor options, Wealthsimple and Justwealth both offer RESP accounts.
TFSA Wins When It Comes To Taxation
In terms of taxation, the TFSA wins out again, being that there is no tax owed on money withdrawn from a tax free savings account! That is a pretty great little feature that the RRSP can’t even match (RRSP withdrawals get taxed at your marginal tax rate). When money is taken out of an RESP, there is rarely any tax paid on it; however, there are still tax considerations. While parents contribute to, and authorize withdrawals from RESPs, the money is taxed as income for the student it is supporting. It is worth noting that the original money that your parents invested in the plan has already been taxed, and consequently that specific money is not taxable to the student, or anyone else for that matter. The only part that is taxable is the government’s 20% match, plus the investment returns on the original principle and the CESG. When a student adds up all of their deductions to the basic exemption for all Canadians, they very rarely have to pay any tax. It is difficult to earn enough money working the limited hours that most students work (at the wages most students make) to have to pay taxes; therefore, the money essentially becomes tax-free income. The final caveat to the student receiving income from an Registered Education Savings Plan is that it will eat into their tax credits which could be saved until a later date, or given to their parents to take advantage of. This is likely a small factor overall, but it is worth mentioning.
Either Way Both Plans Are Great Investment Vehicles
You can’t go wrong contributing to either registered plan, but to maximize your after-tax returns run the numbers for your specific situation. Will your son/daughter be earning a significant income as they go through school? Is there any chance you will need the contribution money in the future? Can you afford to max out both options? These are all questions you should answer either through your own research, or when you sit down with your financial advisor. I believe that in most situations it is tough to beat having the government give you $500 every year, even if the TFSA is a great savings vehicle that offers maximum short- and long-term flexibility.
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