Estimated reading time: 7 minutes
Are you new to investing? Discover what makes RRSPs, TFSAs, or Non-Registered accounts unique and when to use what.
If you are starting to invest, you may have heard about the RRSP and TFSA but not know the difference between them and when you should use each.
One of the most common questions I hear in my job is, ‘What type of investment account should I be saving in?’
Today I will discuss the pros, cons, and best time to use each Canadian investment account.
Three Main Investment Account Types In Canada
Regarding basic investing, you can use three main account types: an RRSP, a TFSA, or a non-registered account.
Each has positives and negatives, so figuring out the most valuable for your current situation is helpful.
You can hold various investments (stocks, mutual funds, ETFs, etc.) in any of these accounts; there are a few limitations in RRSPs and TFSAs, but this will likely never come up unless you are a very high-risk, speculative investor.
RRSP Investment (Registered Retirement Savings Plan)
Since you are here reading a blog about finance, I assume you have heard of an RRSP.
According to Stats Canada research, approximately 4.2 million Canadians aged 25 and 54 contributed to an RRSP in 2013.
That’s about 28% of the total population in that age group.
Why Contribute To An RRSP Investment Account
So why are so many people investing in RRSP’s?
You might think the main benefit they provide is the tax refund, but the real advantage is that an RRSP allows you to defer tax until later (usually in retirement).
That means you can put money in and then not have to pay tax on it until you withdraw.
To make the most of the RRSP, you want to ensure you make your RRSP contributions in a higher tax bracket than when you withdraw the funds.
Let’s say you earn an income of $40,000 and make an RRSP deposit of $1,000.
This would get you a refund on your taxes of $250 (I’m basing that on the Alberta marginal tax rate of 25%, but it will vary by province).
Now, let’s jump forward to your retirement and go ahead and withdraw that original $1,000 contribution.
Maybe you are lucky enough to have a pension, and your retirement income is $60,000.
Your marginal tax rate would then be 30.5% in retirement, and you would have to pay $305 in tax for that withdrawal…so much for that tax advantage!
Delaying RRSP Investment Contributions
This is why delaying RRSP investment contributions until you are in your peak earning years to get the most significant tax break in retirement makes a lot of sense.
There are, however, a few exceptions.
If your employer provides an RRSP matching plan, you will ALWAYS want to take advantage of that; it’s free money in your pocket.
Another time is if you are saving up for your first home. Canada has the First-Time Home Buyers incentive program that allows you to withdraw money from your RRSP tax-free if that money is to buy your first home.
You have to pay the money back over the next 15 years, but using the tax refund you will get can help you hit your down-payment target faster.
You can’t just contribute unlimited amounts of money to an RRSP; you must earn contribution room by earning employment income.
How Much RRSP Investment Room Do I Have?
Each year, you will get 18% of your income as an RRSP room, up to an annual maximum (for 2017, that maximum is $26,010).
Any unused contribution room will carry over indefinitely, so you can store it until it makes the most sense to start contributing.
To find out how much room you have, you can check your notice of assessment or log in to your CRA profile.
Understanding The TFSA Investment Program
The TFSA (Tax-Free Savings Account) was introduced in 2009 and has increased in popularity ever since.
Unlike an RRSP, you do not get a tax refund when contributing to a TFSA.
Your money, however, grows tax-free in the account, and you never have to pay tax on it, not even when you withdraw the funds down the road.
Let’s say you invested $10,000 today, which grew to $100,000; You would usually have to pay tax on that $90,000 of growth.
If your capital gains tax rate is 18%, that would be a tax bill of $16,200, but if you had made that investment within a TFSA, you wouldn’t pay any tax.
Like an RRSP, the government limits your contribution to a TFSA each year.
TFSA Investment Limit Breakdown
As of 2017, the total contribution is $52,000, but the annual limit has varied.
TFSA limit for 2019 is $6000
- 2009 to 2012 – $5,000
- 2013 to 2014 – $5,500
- 2015 – $10,000
- 2016 to 2018 – $5,500
- 2019-2022 – $6000
- 2023 – $6500
The TFSA annual room limit will be indexed to inflation and rounded to the nearest $500.
To contribute to a TFSA, you must be Canadian and over 18.
If you only turned 18 in 2012, you would not have earned the room from 2009 to 2011.
Benefits Of Investing In A TFSA
TFSAs are much more flexible than an RRSP account and can be used for short- or long-term savings.
Some people use their TFSA as anemergency fund, to save for a vacation, or as an alternate retirement savings account.
These options are possible because you can withdraw anytime without tax or penalty.
Another benefit is that you can replace the total amount of any withdrawals you make.
You have to wait until the following year, but if you withdraw $15,000 in 2017, you can put that amount back in 2018.
Non-Registered Investment Account
Registered accounts, like RRSP’s and TFSA’s, have rules and restrictions established by the government, but there are also non-registered accounts that can provide more flexibility to your investment portfolio.
These can vary from a simple savings account at your bank to an actual investment account held with a brokerage.
There are no limits to how much money you can deposit or what investments are held, but you don’t get the preferential tax treatment you do with TFSA’s or RRSP’s.
Investments in a non-registered account are taxed on an ongoing basis.
Depending on what you hold, you could be looking at tax slips for capital gains, dividend income, or interest.
If you are making money on your non-registered investments, you will be looking at an annual tax bill.
TFSA, RRSP, or Non-Registered Investment – The Best Choice
Deciding which type of investment account to save in depends on your situation, but there are a couple of guidelines you can follow:
- Investing in an RRSP should be for long-term planning, and you should do it when your current income is higher than what you expect in retirement.
- TFSAs are similar to non-registered accounts but with better tax treatment. You should always max out your TFSA before turning to non-registered investments.
Hopefully, that gives you some clarity on the options available to you for saving money.
If you have any questions, please post them in the comments below.
Discussion Question:Did you learn anything new today from this post?
If yes, please share in the comments below.
Post Contribution:Hey everyone, I’m Sarah, and I blog about personal finance atSmile & Conquer. Mr. CBB has been kind enough to open his blog to me for a guest post. I live in Edmonton, Alberta, with my boyfriend, two dogs, and two cats. I have blogged for about a year and a half, but I’ve worked my day job in finance for almost a decade.
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