So you’ve got some money to invest. Where do you put it?
One catch about making money on investments is that the taxman will want its share. So to incentivize Canadians to save for retirement and education, the federal government introduced some special accounts over the years that let you defer income tax in the beginning or avoid it later on: the RRSP, TFSA and RESP
In an ideal scenario, you might choose all these things: max out your RRSP, TFSA and RESP contributions and have a little left over to save up for your next vacation. But this is real life, and real life can get expensive. Don’t feel bad if your investing abilities don’t meet up with your aspirations. Instead, get smarter about the money you do have, and put it to work for a better future.
What exactly are RRSPs, RESPs and TFSAs?
No one loves an acronym more than government, and you can thank ours for coming up with these three. What they all have in common: They’re registered accounts, meaning the government tracks your contributions, and they come with perks to help you save and invest more. Here are the basics.
What it stands for: Registered retirement savings plan
What it’s for: Like the name says, it’s for retirement. The idea is that you put money in this account and leave it alone until you’re no longer working.
How much you can contribute: There’s an annual limit of a certain percentage of your earnings up to a specific maximum. In 2023, that’s 18 per cent of your previous year’s earned income, or $30,780 – whichever is less. If you haven’t hit your contribution limit in previous years, that amount is still available to you.
How it works: RRSP contributions essentially reduce your taxable income for that year. The simple explanation (your reality might be different): Say you have a salary of $80,000 and deposit $10,000 into your RRSP. Your income tax bill will then be calculated on $70,000, and if your employer deducted taxes payable for that extra $10,000, you’ll get those taxes back in the form of a refund. The catch? When you eventually pull money back out of your RRSP, it’s considered taxable income.
What it stands for: Tax-free savings account
What it’s for: This one’s a bit more up for debate. The name implies that it’s for saving, and many Canadians use it for just that: putting money aside for a down payment, tuition or other big expenses. But many experts think that its best use is as a retirement savings tool, for tax reasons (see below).
How much you can contribute: There’s an annual limit that’s the same for everyone. In 2022, it’s $6,000. The limit carries over year by year so if you don’t contribute the maximum you can make it up in later years. If you take money out, you can also hold on to that contribution room and make it up later (just not in the same year).
How it works: Your eligibility starts when you’re 18. You don’t get any immediate tax break from putting money in your TFSA – contributions are from after-tax dollars. The benefit is that you don’t have to pay tax on withdrawals, including both your initial contribution and any investment returns.
What it stands for: Registered education savings plan
What it’s for: Saving toward future education costs for the kids in your life.
How much you can contribute: There’s a lifetime limit of $50,000 per child. There is no annual limit on how much you can put away.
How it works: Similar to RRSPs, this is a kind of tax-deferral system. The original funds you put in are after-tax dollars, so they won’t be taxed when you take them out again, and the earnings on that money – the dividends, interest and capital gains – aren’t taxed until they are withdrawn. They’re taxable income for the student, though, which means the rate will probably be low.
RESPs come with an added perk besides being a tax shelter: The government will top up your deposits to a lifetime maximum of $7,200 per child, with an extra $2,000 per child available in grants to low-income families. Those top-ups can make a big difference. In addition to your own contributions, up to a maximum $2,500 a year, your account will get a 20 per cent boost (on the annual maximum $2,500, that’s an extra $500), and who can beat returns like that?
RRSP vs. RESP vs. TFSA: Questions to ask yourself
Does an RESP apply to you?
When deciding between an RRSP, RESP and TFSA, the first question to ask is: Are there kids in your life whose education you want to contribute to? If the answer is yes, then it’s worth setting up an RESP account if the kids are yours, or chatting with their parents or guardians if they’re not. (RESP contributions make a fine, if a little boring, gift to the nieces, nephews and grandkids in your life.)
If the answer is no, then you’ve simplified the question: You’re now down to comparing TFSAs and RRSPs.
Can you get free money?
There might be no such thing as a free lunch, but there is free money you can sometimes tap into to boost your savings, under a few conditions. If it’s accessible to you, that might be a factor in your decision. Those aforementioned government RESP top-ups are one example.
And if you have a workplace RRSP or TFSA program, it’s worth investigating. Some employers will match your contributions, meaning you’re essentially giving yourself a raise by saving for the future.
What’s your tax bracket, and what will it be later?
When it comes to retirement savings, the general guideline is to go TFSA first if your income is on the lower side, and RRSP first if your income is higher. David Field, founder of Papyrus Planning, recommends that clients who make less than $45,000 a year save in a TFSA first and those who make more than $85,000 prioritize the RRSP.
The idea is you want to pay the income tax when you’re at a lower tax rate, and claim any tax savings when your income is higher.
Think about your annual income now and a few years from now, as well as what you anticipate it might be in retirement.
And remember that if you do put money into your RRSP, you don’t necessarily have to claim the deduction in the same tax year. Deductions can be carried forward into future years. This might be useful if you have cash available to invest now but expect to have a higher salary in the next few years.
Do you have a pension?
Since RRSP withdrawals are taxable income, any other income you have during retirement will affect your tax rate. If you’ll be getting a good-sized pension, for instance, you might want to invest additional money in a TFSA, as you can take money out from it whenever you want, and it won’t count toward your taxable income.
Are you good at leaving savings alone?
Since it’s complicated to take money out of RRSPs – and you have to pay tax on what you withdraw – they often feel more untouchable than TFSAs. If you’re trying to save for retirement and you know you’ll be tempted to pull the money out sooner, an RRSP might be the better psychological choice.
When will you need the money?
RRSPs have a lot of rules surrounding them, including when you must start taking money out, and how much. It all begins the year you turn 71. That year, your options are: withdraw the funds (and be taxed on the entire amount); use them to purchase an annuity; or transfer them to a registered retirement income fund, or RRIF. With the latter option, every year you will need to take out at least the minimum amount set by the government. But 71 can be early for some people, for whom RRIF payments might bump them up to a higher tax bracket. “But there are no mandatory withdrawals from a TFSA,” tax expert Tim Cestnick points out. “So, if you don’t need the investments to meet your costs of living, a TFSA can make sense.”
The bottom line: Where should you put your money?
It’s never too late to start saving for retirement or for your kids’ education. But it’s also never too early. The most important thing is to get in the habit of putting money aside. A good budget can help, and automated deductions straight out of your bank account are your friend.
When it comes to choosing between a TFSA, RESP and RRSP, it really depends on your personal financial situation, and everyone is different. The key is that you’re saving at all. Even if you don’t have a lot of money to invest the contributions and returns do add up, and you’ll be in a much better position for the future.