Try to avoid putting U.S.-based dividend-paying stocks or ETFs in the TFSA. Instead,put those into your RRSP or your registered retirement income fund (RRIF). Canadian dividends and interest belong in TFSAs, as do speculative U.S. or foreign stocks that don’t pay dividends.

TFSA or RRSP? Use both if you can

What about the perennial question of which to fund first: TFSA or RRSP? My short answer is to do both. But if you really must choose between the two, I’d pick the TFSA in most situations. Certainly, young people in a low-tax bracket—and older folk who are in danger of seeing OAS or GIS benefits clawed back—should prioritize the TFSA.

But that doesn’t mean young people should avoid RRSPs. Matthew Ardrey, wealth advisor with Toronto-based TriDelta Financial, told me in an email that when he talks to younger friends and colleagues, “They feel that the best way to save is through the TFSA and the RRSP is nothing but a ‘tax trap.’ I am here to say that, though the RRSP does generate taxable income for you upon withdrawal, it is certainly not the trap that some make out to be.”

RRSPs work best when the tax rate upon contribution is higher than when money is withdrawn. If you receive a tax break at 50%, then withdraw the RRSP at 30%, you will be ahead of the TFSA, assuming you saved the refund generated from your RRSP. “This is because the contribution to the TFSA must be made with after-tax income and the RRSP can effectively be made with pre-tax income when saving the refund,” says Ardrey.

Save that refund! 

It’s true that the success of the RRSP is dependent on “saving the refund” and not spending it. Ardrey says the success of TFSA also depends on not pulling money out from it for that same spending. “For better or worse, the tax implications of withdrawing from the RRSP prevents many people from using it during their earning years. The TFSA has no such penalty attached to it. So, for either strategy to be successful, a certain amount of financial discipline must be present.”

Having defended RRSPs, Ardrey adds: “I think the TFSA is the best thing the government has done for retirement savings in a long time. It provides flexibility in savings and [it] can benefit, not only those with a high income level, but those at lower income levels as well. As TFSA withdrawals are tax-free, they do not affect payments made from the OAS and GIS programs” he says adding that the latter is specifically for lower income Canadians. “Conversely, an RRSP withdrawal does affect this.” TFSAs are also great for large lump-sum withdrawals, like when buying a car during high interest rates.

Personally, I believe those with high employment income should maximize their RRSPs, but if they are in the top tax bracket, they can probably also afford to maximize their TFSA. If, despite such a high income, you are encumbered by heavy mortgage debt and/or credit card debt, I’d suggest liquidating some of your TFSA to eliminate what you owe. You can always regain your lost TFSA contribution room in future years. Once you’re debt-free, there should be few obstacles to maximizing retirement savings in all such tax-optimized vehicles, such as registered education savings plans (RESPs) registered disability savings plans (RDSPs) and any new tax-sheltered program Ottawa is planning to help young people save for a first home.)

Don’t let the many benefits of TFSAs blind you to the merits of other tax-effective vehicles. Adrian Mastracci, portfolio manager with Vancouver-based Lycos Asset Management, says families should review which spouse benefits the most by accumulating the saving capacity, and in most cases they shouldn’t limit themselves to using only a TFSA. (Those who are single cannot benefit from income splitting vehicles. 

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