One article to end them all
One of the most common questions we are asked is, “should I put money in my RRSP or my TFSA?” Why so much confusion around this topic? Well, unfortunately, home economics class doesn’t have much about “economics”. Or maybe, like me, you didn’t realize the information being taught would ACTUALLY be valuable in life so it came in one ear and out the other!
Here are some basic guidelines and a little extra info about some common labels and investments. This can be your go-to resource for account and “label” explanations.
First let’s get on the same page regarding language: when we’re talking with you, account types (e.g. RRSP, RESP or TFSA) will be referred to as “labels” and what goes in the account will be called an “investment” (e.g. Mutual Funds, ETFs or Savings Accounts).
RRSPs: Registered Retirement Savings Plans (more commonly called RRSPs) are used to defer paying tax on the money you earned this year. Any money you put under the label of RRSP you don’t have to pay income tax on this year. As a bonus, if your investment makes money it is sheltered, meaning you do not have to include that “income” when you file your income taxes. You only have to pay income tax when you take the money out. As your income increases the amount of tax you can avoid paying through RRSPs also increases, so they are a favourite with people in higher tax brackets.
TFSAs: What a gem the government has given us in the Tax Free Savings Account (TFSA)! The TFSA label is simple and effective for everyone. If your investment makes money it is sheltered, you do not have to include it in your income tax filing, and you don’t have to pay tax on that money when you take it out. For example, if you put in $1,000 and it grew to $10,000, normally you would have to pay tax on the $9,000 of growth. But because that money was under the TFSA label, you don’t have to pay anything! TFSAs are great for people in both a lower income bracket and a high-income bracket. Click To Tweet
RESPs: The Registered Education Savings Plan (RESP) label is the best way to save for your children’s education, and the younger they are when you start the better. Depending on your income, the
government will help by kicking in extra money through Grants and Bonds; most people can expect an extra 20%!
OPEN: Although often forgotten, “Open” is also a label. The open label means the money is not sheltered and has no favourable rules. In general, if you invest under this label anything you earn must be reported as income and you will have to pay tax just like if we worked to earn the income at a job. Don’t get me wrong, having your money make money is pretty cool! Just remember to use the other accounts first! So you understand labels; let’s talk about what you put under those labels – your investments.
Savings Accounts: Generally paying less than 1% interest, savings accounts are not a good place for medium to long term investment money. But here’s the biggest mistake we see: often people will put the TFSA label onto their savings account. It seems to make sense since it’s called a Tax Free SAVINGS Account (thanks to whoever named that. If you worked in my organization you’d be made a volunteer pretty quickly). Contrary to the name, the label TFSA doesn’t have to be applied to just a savings account and, in fact – I can’t shout this loudly enough that – that is the WORST place for it! The awesomeness of the TFSA is that any growth under this label, when withdrawn, is NOT subject to any tax! For example, if you bought a penny stock at $.10 and it grows to $10. If you owned 100 shares it would make $9,000 of “taxable profit” but since you are a money genius and put it under the TFSA label, you don’t pay any tax and keep all the money! TFSA is the label of all labels!
GICs: Guaranteed Investment Certificates (GICs) are contracts that pay interest over a selected period of time. For example, a 5 year GIC at 3% pays 3% per year and is locked-in (meaning you’ll pay a penalty if you withdraw early) for 5 years. This is good for short term money that MUST be available in 5 years. Because of the low growth, GICs are NOT a good investment for long term retirement or education money.
Mutual Funds: Mutual Funds are made up of a pool of money collected from many investors to invest in stocks, bonds or money market instruments and similar assets. Mutual funds are operated by money
managers who invest the fund’s capital and attempt to earn income and capital gains for the mutual fund holders (the investors like you and me). Because they are managed by people, there are fees attached to
mutual funds. However, don’t write them off because of that! Mutual funds are great for people who have a medium to low knowledge base around investing. Tip: Some mutual funds require the money managers to have their own money invested in the mutual fund. Click To Tweet This is a great question to ask your advisor.
ETFs: An exchange traded fund (ETF) is a marketable security that tracks a certain “index” or group of stocks. For example, the Standard & Poor 500 (S&P 500) is a sample of the 500 largest American Companies and the S&P TSX 240 largest Canadian companies. Unlike mutual funds, an ETF trades like a common stock on a stock exchange. ETFs are not managed by money managers; rather, they mimic the corresponding index. Since there is no management ETFs tend to have lower management fees than mutual funds.
One does not simply buy an RRSP. Your Financial Advisor should ask questions and help you determine what accounts and what investments to use – your job is getting in touch with an advisor you like and trust!
Find our more about Graham here, or contact him directly at Graham@yourmoola.ca.