Tax-Free Savings Account (TFSA)

Pay now, party later

TFSA is short for Tax-Free Saving Account. The name is slightly misleading because a TFSA is really an investment account that can hold all the same types of investments as an RRSP.

Why you should have one

With a TFSA, you’ll have to invest after-tax dollars when putting money into the account since there is no tax deduction, unlike an RRSP. On the flip side, the advantage is you can earn investment gains in your account and never pay tax on them. For example, if you invested $5,000 and it grew to $10,000, you could walk away with the whole $10,000. No taxes, no catches.

What you need to know

Similar to an RRSP, there is a limited amount of contribution room. For 2017, the amount is $5,500. Also similar to an RRSP is the fact that you can carry unused room forward. If you’ve never contributed to a TFSA before, you should have more than $50,000 of contribution room available based on the annual limits set since they were introduced in 2009. A neat feature of TFSAs is that you get your contribution back when you make a withdrawal. Take $5,000 out this year, and you’ll have an extra $5,000 of contribution room available for next year.

Registered Retirement Savings Plan (RRSP)

Party now, pay later

RRSP is short for Registered Retirement Savings Plan. The idea with this type of investment account is to avoid paying tax on some of your income today and instead pay it after you retire.

There are two advantages to this

One, it is likely that you will be in a lower tax bracket when you retire. And two, being able to invest more of your money now will lead to a bigger nest egg when it comes time to spend it. Here’s a simplified example: If you made $10,000 and paid income tax at the highest marginal rate of about 50%, you’d have $5,000 left to invest. If you earned 6% annually over the next 20 years, you’d end up with about $16,000. Next, you’d have to pay tax on the gains you made. If you were in a retirement tax bracket of, say, 30%, the taxes on your $11,000 profit would be roughly $3,300, leaving you with $12,700 after all is said and done. Now, if you put that $10,000 in your RRSP instead, you’d pay no income tax on it. You could invest the whole $10,000 at 6% annually for 20 years, and end up with $32,000. This time, you’d have to pay tax on the full amount, not just the profit. But at a retirement tax rate of 30%, you’d still be left with $22,400, or nearly twice as much money.

And also some limitations

One of the limitations of an RRSP is that you are only given contribution room of 18% of your income each year with a cap of roughly $25,000 per year (this figure usually increases a bit each year). The good news is you can carry forward unused contribution room from previous years. Check the Notice of Assessment from your most recent tax return to see how much total contribution room you have available. You can take money out of your RRSP at any time, but there will be withholding tax just like a paycheque.

The exception is when you take money out of your RRSP to buy your first home or to return to school as a mature student. There are programs that allow you to “borrow” from your RRSP for these purposes without paying tax, as long as you pay it back into your RRSP within 15 years for home purchases or 10 years for school.

Registered Education Savings Plan (RESP)

Set your child up for the future.

RESP is short for Registered Education Savings Plan. This type of investment account is used to help a child pay for college or university. The first benefit is the ability to invest in the plan without paying tax on investment gains until withdrawals are made for school. At that time, only the profits are taxable, and only in the name of the child, who will almost certainly be in a very low tax bracket.

Free money from the government

The second benefit is really remarkable: the Canadian Education Savings Grant (CESG) matches 20% of your RESP contributions. That’s like a guaranteed 20% return on investment. The maximum grant is $500 per year up to a lifetime maximum of $7,200 per child. An RESP can remain open for 36 years. If your child still hasn’t made it to university by then, all is not lost; you can generally transfer the account to another child, or to your RRSP (minus the government grants).

Just a heads up

Be wary of companies that offer Group RESPs. This is an outdated financial product that thousands of Canadians still purchase every year, probably unaware that there are unnecessarily high fees, low investment returns, and strict rules that can cause you to lose all of your investment gains and government grants.

Non-Registered Account

No special tax features

A regular, run-of-the-mill investment account with no special tax features is often referred to as a non-registered account. This is the type of account you’ll generally invest in after you’ve used up your RRSP and TFSA contribution limits. You don’t get to deduct your contributions from your taxes or earn tax-free investment returns with this type of account, but that doesn’t stop you from doing some tax planning.

The best types of investments for this account

This mostly comes down to which types of investments you choose to hold in the account. Interest income is taxed at your full marginal rate, just like your salary. This makes bonds, GICs, and other interest-bearing investments the least desirable choice for your taxable account. Dividends from Canadian corporations are taxed at a lower rate than interest income. This makes Canadian dividend-paying shares or ETFs a little more attractive for this type of account. Capital gains are only 50% taxable. For example, if you invest $5,000 and it grows to $10,000, you’ll only pay tax on $2,500, or half your gain. This makes common shares or growth-oriented ETFs the most attractive investment for this type of account, at least from a tax point of view.

Locked-In Retirement Account (LIRA)

Similar to an RRSP, with some exceptions

LIRA is short for Locked-In Retirement Account. This is a close cousin of the RRSP, except with some additional restrictions. A LIRA is created when you leave a job and transfer money out of a company pension plan. Once it’s in your LIRA, you can manage the money yourself and invest it as you wish, just like an RRSP.

The catch

The catch is that you can’t put more money in, and it’s difficult to take any money out of a LIRA before retirement. With an RRSP, you can access your money at any time as long as you pay tax on the withdrawal. You can also make tax-free withdrawals with some conditions to pay for school or a first home. Not so with a Lira. About the only way to access the money before retirement is by proving financial hardship based on standards that vary by province.

Registered Retirement Income Fund (RRIF) and Locked-In Retirement Income Fund (LRIF)

Made to enjoy the fruits of your labour

RRIF is short for Registered Retirement Income Fund. LRIF stands for Locked-in Retirement Income Fund. They are both variations on the same theme: these are the accounts that an RRSP or LIRA must be turned into by the time you turn 71. You use them for taking money out rather than putting money in.

Managing your withdrawals

The government requires you to withdraw a certain minimum amount every year. If you take only the minimum amount, the money should last for the rest of your life (at least based on their actuarial tables). You are free to withdraw as much as you like, but be aware that every dollar is taxable. Therefore, it takes some tax planning to make sure that your sources of retirement income add up to enough money to meet your expenses without going over and putting you in a higher tax bracket.

Spousal RRIF

Made for you and your partner to enjoy retirement

So you and your partner have your Spousal RRSP and are about to retire. It’s time to switch this account over to a Spousal Registered Retirement Income Fund (Spousal RRIF). Just like an individual RRSP, this account is what your Spousal RRSP must be turned into by the time you hit 71. You and your partner use this to take money out as an income rather than adding to it.

The three year attribution rule

There is a rule that is unique to this account compared to an individual RRIF. The three year attribution rule applies to couples that take their retirement savings out too early in order to cheat the tax system. As an example, one spouse earns more than the other and they put $5000 in their spouse’s RRSP to take the tax deduction. The spouse earning less now takes that cash out the following year and the other dodges the taxes from the year before. Since it’s been less than three years that they’ve put the $5000 into the account, the one earning more will have the $5000 added to their income and will have to pay the tax.

Spousal RRSP

If one of you make a lot more than the other, this is a great account for you.

A Spousal RRSP is a lot like a regular RRSP, except one spouse is allowed to make some or all of their annual RRSP contribution to an account in the name of the other spouse. This comes in handy when there is a large income disparity between the two. Now, the higher-earner gets the full, immediate tax relief when a contribution is made, but the lower-earning spouse gets the tax liability down the road when the money is withdrawn. The goal is to achieve a lower tax rate and a smaller overall tax bill for the couple when they retire.

Two things to keep in mind

Whether you just have your own RRSP or your own RRSP plus a Spousal RRSP, your annual new contribution room is still limited to 18% of your income up to a fixed cap, and any unused room from one year can be carried forward indefinitely. Also, in order to discourage cheating, the government will attribute the taxes back to the contributor on any amounts that stay in a Spousal RRSP for less than three years.

Group Retirement Savings Plan (GRSP)

Similar to an RRSP

First off, a GRSP (or Group Retirement Savings Plan), acts just like an individual RRSP. Invest your money tax-free and only pay tax once you withdraw from this account. 18% of your income can be put into this account every year to a max of $26,230 (2018).

So, what’s the difference? A GRSP is administered by your employer. If you leave your job there’s no problem, since you can take it with you without penalty or take money out of it, as long as you pay the tax.

Free Contributions from your employer

The biggest advantage of a GRSP is that employers often chip in. That means free money for you. They can match your contributions up to 3 and 5% of your salary. Now that’s something to get excited about.

Something to think about

There are some drawbacks to this type of account compared to a regular RRSP. For one, the company decides who manages the account. This makes for a limited choice and not great for someone who wants complete control over how their investments are managed. Secondly, Some plans restrict employers from taking money out of the account after they leave the company. Keep an eye out for this before making a final decision.

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