For decades, investment advisors and financial planners have told clients that the best way to ensure a comfortable retirement is to maximize contributions to their RRSPs. With a few exceptions, that remains unquestionably good advice.

But starting in the 2009 tax year, Canadians will have the tax-free savings account in their arsenals, a powerful new tool they can use to save for retirement or any other goal, in addition to the RRSP. The TFSA, proposed in the 2008 federal budget, promises to be an essential companion to the RRSP in a Canadian’s financial set-up.

So, the question that clients will be asking their advisors next year is: “Where should I put my money?” In many cases, the answer will be obvious.

“If you have unlimited funds, you’re going to do both,” says Jamie Golombek, vice president of tax and estate planning with AIM Funds Management Inc. in Toronto. The tax-deferral component of the RRSP will help clients lower taxes today and accumulate for their retirement, while the TFSA will allow clients to save for whatever purpose, using after-tax funds. Both programs allow Canadians to grow money tax-free while in the accounts.

Of the two, however, the RRSP will most often take precedence, experts says.

“All other things being equal, the RRSP is generally preferable to the TFSA, due to the up-front tax savings,” says Patricia Lovett-Reid, senior vice president with TD Waterhouse Canada Inc. in Toronto.

Golombek agrees: “Most people, other than people in the lowest tax bracket, would be much better off with an RRSP because their tax rate today should be higher than their tax rate upon retirement.”

Still, the TFSA — which will allow Canadians to invest $5,000 a year in after-tax money in a tax-free account and withdraw it at any time without paying taxes — is a wonderful program no client should be without, experts say. Unused contribution room can be carried forward indefinitely, and any amounts removed from a TFSA will free up an identical amount of contribution room in future years.

“If anyone has an extra $5,000 a year to invest, or $5,000 sitting in a non-registered account, then you have to put it into a TFSA, for sure,” Golombek says. “It’s a no-brainer.”

The TFSA vs RRSP question really comes into play when a client has only a limited amount of money to invest and must choose between the two.

Because the TFSA allows an investor to remove money tax-free, it would represent the better option for Canadians who believe they will be in a higher tax bracket in retirement, experts say. Money removed from a TFSA wouldn’t be counted as income and wouldn’t endanger social benefits such as old-age security or the guaranteed income supplement.

Meanwhile, contributing to an RRSP would be a preferable option for clients who believe they will be in a lower tax bracket in retirement because they could then take that money out with a relatively low tax hit. And they would have enjoyed tax deferral from the time of contribution. Most working Canadians would fit into this “high-income now/low-income later” scenario.

If a client remains in the same tax bracket during his or her working life and into retirement, Golombek says, then the TFSA vs RRSP argument ends in a wash.

To illustrate, Golombek uses an example of a client who earns $5,000 in pre-tax income and falls into the 40% tax bracket. If the client doesn’t contribute the money to an RRSP, that money will be taxed. He or she will then have $3,000 to invest in a TFSA. If no other contribution is made, then after 20 years, at a growth rate of 6% a year, the net amount at the time of withdrawal would be $9,621.41.

On the other hand, assume the client puts $5,000 of income in an RRSP. (No taxes are paid because a deduction is claimed.) If no other contribution is made, after 20 years, at the same growth rate of 6% a year, the $5,000 will grow into $16,035.68. Upon withdrawal, a tax hit of 40% will leave the client with $9,621.41 — the identical amount as in the TFSA scenario.

In practice, most Canadians will look to use the RRSP and the TFSA in tandem. For example, clients could invest in an RRSP and use the tax refund to make a contribution to a TFSA, or save in a TFSA and use that money to make an RRSP contribution when the client is in a higher tax bracket.

@page_break@Experts are excited by the flexibility the TFSA offers.

“When we first got the budget, we were looking at the TFSA, saying, ‘Where’s the downside to this?’” recalls Dave Ablett, senior tax and retirement specialist at Investors Group Inc. in Winnipeg. “It’s an extremely generous and flexible plan.”

Ablett says that a TFSA probably will fit into a client’s plan at any life stage, from young adult to retiree. For example, young people, who are usually in lower tax brackets, could use the TFSA to build an emergency reserve or save for a car or a down payment for a home.

“My guess is that in five to 10 years, you will probably see fewer people using the Homebuyers’ Plan or the Lifelong Learning Plan,” Ablett says. “With the Home-buyers’ Plan, you have the repayment schedule, there are certain rules concerning what constitutes a first-time homebuyer, etc. Well, with the TFSA, you don’t have to worry about any of that.”

Couples planning for children could use a TFSA to fund the difference between parental-leave pay and a salary. And entrepreneurs and small-business owners with fluctuating incomes can use a TFSA to build a reserve for periods of low income.

Workers with generous defined-benefit pension plans often find they have little RRSP contribution room. A TFSA will give them another option to build assets tax-free. For those approaching retirement, the TFSA will offer a way to build additional retirement reserves when RRSPs are maxed out.

Seniors, in particular, will benefit from the creation of the TFSA, experts say. The TFSA will allow those over 71 — the age at which Canadians must convert their RRSPs to RRIFs or annuities — an opportunity to shelter more of their assets from taxes. And as TFSAs aren’t taxable, they can be left to an estate without tax consequences.

A bequeathed TFSA “could be used to pay tax liabilities [of an RRSP, for example] or to fund a large charitable donation,” Ablett says. “And that could be used to offset some of the tax liabilities.”

In fact, the flexibility of a TFSA is so great, and its potential for tax savings so large, that the challenge for Canadian financial institutions will be how best to market their TFSA product and educate consumers.

“We have a year to get it right,” says Lovett-Reid. “The ante [for firms] will be in getting the message [of the TFSA] out there. You’re not going to be the financial institution that doesn’t promote this product — because it’s in the best interests of the client.”

Firms that get it right will probably have an edge over competitors, she says: “It’s going to be in the simplicity of the messaging, not the simpleness of the product.” IE