Net worth: Top savings vehicle for young people

Question

My 22-year-old has just started his career. He was able to graduate without too much student debt and now has some money to put towards the future. Can you weigh in on the question of whether an RRSP or a TFSA is the best place to start?

Answer

The RRSP. RRSP. RRSP. The RRSP is the best place to start. Was that too subtle? Should I spell it out? Registered Retirement Savings Plan.There.Start there.

I don’t think the TFSA even comes close to the RRSP, but I know not everyone agrees with me. The basic argument in favour of the TFSA over the RRSP for young people is that your son is in a low tax bracket now and will likely be at a higher one in the future, so the tax deferral will be more valuable then. True, but I’d still start with an RRSP for a few very important reasons.

1. Engrain the habit of long-term saving: The stats on RRSP contributions are dismal–just 26% of those eligible made a contribution in 2010–yet it remains such a great program for building wealth. If your son starts contributing now, before the pull of mortgage/kids/golf clubs becomes irresistible, there is a higher probability that he’ll be able to stick with the habit over time. Engraining the RRSP habit is the key thing, and is more important than the amount of the contribution itself.

1. Make compounding count: Your son has time on his side and the earlier he starts saving for retirement, the easier it is going to be because he’ll keep earning interest on his interest. The TFSA is a great place to save for shorter-term goals like a house or a car. But the RRSP is better when it comes to retirement in part because it is harder to take the money out, so its more likely that he’ll leave it in and benefit from compounding over the next four or five decades.

1. RRSPs still provide some flexibility: If your son decides that he wants borrow some money from his RRSP to put towards a down payment on his first house or fund further education, he can do that.  He can also contribute to his RRSP but choose when he wants to actually take advantage of the tax deferral, either now or when he’s earning more money and in a higher tax bracket.

Sure, your son could open up a TFSA in addition to an RRSP, but I would highly recommend that his first priority is to set up an automatic withdrawal, every pay day, moving money from his bank account to his RRSP.

RRSP first. Was I clear?

About Bruce Sellery

Bruce Sellery is the CEO of Credit Canada, the country’s longest-standing non-profit credit counselling agency. He is a former MoneySense columnist.