What opportunities do Canadians have to make their extra money go the furthest for them? Saving for the future is one of the best decisions an individual can make, but there is more than one way to make your money work for you. When investing in the stock market, there are countless ways to do this; in this article we will discuss the three most common ways to hold stocks – Registered Retirement Savings Plan (RRSP), Tax Free Savings Account (TFSA), and an unregistered account (sometimes called an “Open” account). At Navigate CPA, when we talk to clients about how to maximize their money, we often talk about TFSA’s and RRSP’s as well as Open accounts. In the opinion of Navigate CPA, the strongest tax deduction available for all Canadians is investing in an RRSP. RRSP’s provide immediate tax relief, continued tax-free growth and also peace of mind and financial security for the future. Like many Canadians, you may not realize that the largest expenditure you will make in your life is taxes (although depending on where you live, your home might take top spot). There are a number of types of savings accounts that can help alleviate your yearly tax bill and help you save for retirement, and today we’ll be exploring two of the most popular.
One of the most common and well-known savings opportunities is a Registered Retirement Savings Plans (RRSP). For every dollar that you contribute to an RRSP, the government will credit you (i.e. pay you a tax refund in cash) at the highest tax rate you are currently paying. For example, in BC, at a salary of $70,000 per year, you would receive $282 back for every $1,000 RRSP contribution you make. You could think of this as a 28% return on your investment right out of the gate. This helps make RRSP contributions a great way to manage the amount of tax you will be paying. Note that the refund amount fluctuates as you contribute more/less or earn more/less, so be sure to discuss this with your small business accountant.
The Government of Canada provides you with RRSP room equal 18% of your earned income each year. In 2023, the maximum an individual could contribute to an RRSP was $30,780. If in years past, savings goals have lead you to put your money elsewhere, not to worry – any unused RRSP room from previous years is rolled over and accumulated, meaning you might have more opportunity to invest in your RRSP’s than you realize.
There are some drawbacks with RRSP’s that are important to consider. While you do not pay any tax on the growth of RRSP’s, you do pay tax on withdrawals, and from a tax perspective, it is far wiser to withdraw from your RRSP during your low-income years (i.e. retirement). When you withdraw from your RRSP, not only are you taxed, but you also lose any that “room” in your total investment pool, meaning you cannot replace those monies in the future.
At 71, all Canadians must convert their RRSP’s to Registered Retirement Income Funds, which provide you with yearly income. Here’s an example of what your retirement plan could look like if you take advantage of your RRSP opportunities.
If at age 35, you begin to contribute $5,000 a year to your RRSP, by your 71st birthday, you would have $1,070,259 (assuming 7% rate of return and all tax refunds reinvested). If you invested in a regular investment account, on your 71st birthday, this same yearly investment would have $509,195 (assuming the same rate of return as the RRSP). That is $561,064 more in your RRSP account, which is more than double the return on investment.
Roughly half of Canadians do not contribute to their RRSP’s, which is a huge missed opportunity, both regarding the ability to save for a happy and fiscally healthy retirement and the opportunity for yearly tax savings over the course of your life.
RRSP’s are a great way to save, but they aren’t your only option. A Tax Free Savings Account (TFSA) is an account that has a set amount of room per year (in 2023, that set amount is $6500, but year over year, that amount does fluctuate). While unlike an RRSP, you do not receive any tax deductions when contributing, you are not taxed on the growth of your investment, and you have the flexibility to contribute and withdraw at any time (there are some technicalities when re-contributing after a withdrawal).
Using the same savings example as above, let’s look at how contributing to a TFSA as a retirement savings plan can benefit you.
If you invest $5,000 per year from your 35th birthday until your 71st birthday, you will have saved $829,752 (assuming 7% rate of return), whereas in a regular investment account on your 71st birthday you would have $509,195 (assuming the same rate of return as the TFSA). Contributing to a TFSA account allows your savings to earn you an additional $320,557.
Regarding withdrawing funds over the course of your life, you do have that flexibility, and you do not lose the accumulated room to contribute to your TFSA account – if you withdraw, you simply have a set amount of time to put the funds back.
So how can you decide which account is right for you? Determining your primary objective or goal for your savings will often point you in the right direction.
If your goal is to save on your yearly taxes and save for your retirement, then maxing out your annual RRSPs is likely the best course of action. If you have the opportunity to borrow funds to max out those dollars, it can be worth it. Contact Kent Greaves to discuss if maximizing your RRSP’s makes sense for you.
If your goal is to save, but you’d still like to access your funds with plans to put the money back into the account, then opt for a TFSA. Call Kent Greaves to discuss the pros and cons in choosing a TFSA over an RRSP.
If you have something specific in mind that you are saving for, opting for a TFSA over an RRSP is a stronger choice, as you will not lose room in your accumulated pool of funds when you withdraw those monies and you also won’t be taxed on those withdrawals. There are two exceptions to this, as the Home Buyers Plan allows first-time home buyers to withdraw funds from their RRSP for a down payment on a property and the Life Long Learning Plan allows you to withdraw funds for educational opportunities.
At Navigate CPA, we have found that families who properly plan and save for retirement max out their RRSP savings year after year, as opposed to not planning and “hoping for the best”. Contact Navigate CPA for help devising a detailed and fruitful retirement savings plan.
Disclaimer: tax rules change frequently and can depend on your individual circumstances. The above is not to be relied upon as tax advice and is meant for information purposes only. Please consult a tax professional.