TFSA, RRSP, RESPs 4-Letter Tax Deductible Savings Vehicles
TL&DR: Registered accounts are one vehicle to help lower your taxable income and save for your future.
You’ve probably heard someone nagging you about opening a registered savings account of some kind.
Registered accounts are the governments way of help Canadians save money for things it considers important - like education or retirement.
The TFSA
Short for Tax-Free Savings Account, this is a registered government account. Unlike your checking or savings account, this money doesn't get used by banks for lending. You can open one with all major financial institutions.
With this account, you can buy investment products listed on registered exchanges (stocks, mutual funds on the TSX, NYSE, or Nasdaq exchanges). The most important thing to note is that gains made from either selling these assets (things you own that have value in the open market) for a profit or collecting dividend payments ARE NOT TAXED. Usually, profits from the sale of stocks are subject to Capital Gains Tax (tax owed because you bought something and sold it for more than it's worth), and dividend income is subject to income tax (as if you had an extra job that was paying you).
It should be noted that someone WAS recently taxed on investment gains made in his TFSA, but that was because he was aggressively day trading. Don't trade a huge number of times per day, and you should be fine.
Additionally, if you invest in a non-qualified investment (the rules are complicated, but they mostly involve things like land or general partnerships that are hard to turn into fast cash), they will be taxed.
Furthermore, if you move to another country (for more than 183-ish days in any tax year) and lose your tax residency, you will be charged 1% per month on the account's value.
There is a contribution limit. Starting from the year in which you turned 18 (regardless of whether or not you opened a TFSA at that time), you can contribute $6,500 per year. According to the government website, this amount is indexed to inflation but rounded to the nearest $500 (meaning that it will be 6500 for a while until inflation turns that into > $6751, at which point it will automatically increase to a limit of $7,000).
Most brokers will allow you to open one inside their app and register it with your bank in about five minutes.
For more information on the TFSA, see the Government of Canada CRA Page.
The RRSP
The Registered Retirement Savings Plan is a long-term savings vehicle. It is another registered account that you open with your financial institution. The TFSA is for short- to medium-term savings goals (say, 5–15 years away). RRSP money is set aside for after you turn 65.
What goes in this account?
In this account, you are allowed to hold all the same things as a TFSA (cash, stocks, ETFs, etc.). Also, like a TFSA, do not put things in there that benefit you because you have them. The example they give is holding shares of a ski resort that gives you a discount because you are a shareholder. If these shares are in your RRSP, you will be taxed on the full amount of the discount.
Again, to keep things simple, most people should put things in their RRSP that they could quickly sell for cash through a broker (WealthSimple, Quest Trade, Robinhood, etc.).
Tax Benefits?
100% of the money you contribute to an RRSP is tax-deductible. This simply means that if you make $100,000 per year and you decide to contribute $15,000 to your RRSP, your income taxes get calculated as if you only made $85,000 that year before other deductions are considered.
Tax Implications?
The RRSP is money the government encourages you to set aside after you turn 65. They don’t want you withdrawing it earlier, so attempts to do so are met with tax penalties (withholding taxes).
10% on withdrawals $0-$5000
20% on withdrawals $5000-$15,000
30% on withdrawals greater than $15,000
After you turn 65, you still pay taxes on the money you take out. Instead of a withholding tax, your RRSP withdrawals are considered a source of income and taxed like one. You can still work and earn income from other sources; RRSP money will be included in that tax calculation.
There is an exception to the withholding tax for people buying their first home. You can withdraw up to $35,000 to buy or build a home that will be your primary residence (the place you actually live).
Contribution Limits?
Whichever is lower: 18% of your previous yearly income or $29,210 (as of 2022). This is a hard limit. Overpayments greater than $2,000 are subject to a 1% monthly penalty until they are removed. You might be able to convince the CRA that it was an accident and get them to waive the tax.
For more information on the RRSP, see the Government of Canada CRA Page.
The RESP
The Registered Education Savings Plan was created by the government to encourage parents to help pay for their kids university or college education.
There are no tax deductions for contributions to this account.
As only the registered beneficiary (the person who gets the money) is legally allowed to receive the funds, there are no taxes on a withdrawal.
Unlike TFSAs and RRSPs, there are no yearly contribution limits, but the lifetime contribution limit is $50,000.
For more information on RESPs, see the Government of Canada’s CRA Page.
Final Thoughts
Saving money can be difficult and stressful, but a lot less so than realising you don’t have enough at the time that you need it. As we discussed in What is Interest and How Does It Actually Work? It is far easier to reach your long-term savings goals (vacation, car, down payment for a house, etc.) when you start with small payments as soon as possible. Even if you only have $5–$10 a month to spare, you should save it here in a managed account using a robot advisor.
As I mentioned on Monday, it is very important to start a relationship with a licenced tax professional. They can help you understand what makes the most sense when filing and get you the best value for every tax year.
Happy saving, everyone!
Sincerely,
James R. Davies