If you live in Canada, you’ve probably heard of these acronyms. These are types of programs and accounts you can sign up for to invest your money. Most people use them for retirement and long-term planning. They all have pros and cons so let’s introduce them in this article to see which one are a better fit for you! Perhaps, all of them will suit your financial goals.
When you book an appointment to start investing with a financial advisor, s/he will introduce you to two popular accounts, Tax-Free Savings Accounts (TFSA) and Registered Retirement Savings Plans (RRSP). We will learn the advantages of having these two accounts and see how you can optimize your taxes. Overall, they can help you save money for a mortgage, help you pay for a student loan, set up an emergency health plan, gather financial care for someone else… You can check you RRSP and TFSA contribution room on the Canada Revenue Agency after you log in to your account. Another great investment option for parents are Registered Education Savings Plans (RESPs) to help them save for their children’s post-secondary education.
Tax-Free Savings Accounts (TFSAs)
TFSAs are a type of account created by the government to encourage its citizens to save more money for their future. And this money won’t ever be taxed! Each year in Canada, you can contribute up to $5,500. However, the contribution room depends on the years as it’s subject to changes. For example, in 2015, the yearly contribution was $10,000! Since the money isn’t taxed, do not choose a low-risk savings account for your TFSA. Choose to invest in mutual funds or ETFs because all your earnings won’t be taxed.
TFSAs are available for Canadian residents (you must have an address and live in Canada and have a SIN) and be over 18 years old. It’s a friendly account, you can withdraw money whenever you need and not pay fees or taxes. Over time, this account is more advantageous than an RRSP account.
When you add money to this account, it’s not tax-deductible, however you do not pay taxes on your interests. You could add too much money, and this will cost you 1% in tax per month, so beware of excess contribution.
Registered Retirement Savings Plans (RRSPs)
RRSPs are a type of account that lets you reduce your taxes. You can optimize your RRSP by contributing to your account when you earn a large income (during the peak of your career) and withdraw during years when your income is lower (when you are retired or unemployed). RRSPs are tax deductible, meaning that you are entitled to a tax refund when you file your taxes. When you withdraw money from your RRSP account, you get taxed as an income and your contribution room is gone forever, so it’s not optimal to withdraw when you make a lot of money.
Here’s how it works. The more years you work, the more room you have to make contributions. As you work each year, you can contribute up to 18% of your salary to this account. In 2018, you could contribute for up to $26,230, on top of your prior cumulated years.
There are few advantages to have this account. For example, if you’d like to buy a home, you can withdraw up to $25k from your RRSP account and pay no taxes on it. However, you ought to repay it within 15 years max. In the lifelong learning plan, you can withdraw up to $20k and repay within 10 years max.
Registered Education Savings Plans (RESPs)
RESPs are sponsored by the Canadian government to encourage parents to invest in their children’s future education. Universities are notoriously costly, and parents can start saving money early to afford their kids’ post-secondary education. The money invested in this account yields tax-free returns and the government matches the money up to a percentage to help parents when children are under 18 years old. The contribution is limited to $50,000 per beneficiary.
You won’t get a tax deduction for investing in a RESP account. The money you receive from the government is taxed to students but since they do not (or barely) have an income, they won’t be taxed much. This account can be account by parents, but also a guardian like an aunt or uncle. If the kid decides to not go to college within 36 years of opening the RESP account, the government can claim the money back. Namely, there is a penalty if you withdraw the money for expenses that are not related to education.
In conclusion, TFSAs and RRSPs are the must-have accounts that all Canadian workers should have to invest their money in. Learning to optimize taxes and savings is tricky but it will all be worth it once you sign up for an automatic monthly deposit. Beware of excess contributions each year as you may get penalties. Check out RESPs if you are a parent or would like to become one. It brings many financial advantages as education is never a bad investment.