What to know about them and how to optimally use them
While every effort has been made to make this article factually correct, we are not finance professionals, so please don’t take this as financial advice.
Saving money is the norm in a lot of immigrant cultures and while saving a percentage of your income is the first step to good financial health, investments can help set you up for a better future. The Canadian Government does offer a safety net when you retire, but Old Age Security pension (OAS) and Canada Pension Plan (CPP) are meant to help pad your retirement rather than be your sole source of income. Investing your savings to increase their value over time can also protect your money from devaluation – inflation will result in a drastic decrease in your dollars’ buying power.
The Canadian financial system offers a few investment accounts to help grow your money while saving for retirement. It is important to understand each account, so that you can make them work to suit your specific situation.
Tax-free Savings Account (TFSA)
This registered account is a basket that can carry your investments – it offers a certain contribution room for everyone every year. Its biggest advantage is that the Government does not tax you on the growth of the investment you make within this account.
You can withdraw from a TFSA when you need to without penalties. The universal contribution limit for the year is ascertained by the Government after the tax season and your unused room is cumulative – if you have a balance left in your TFSA limit in the previous or current year, it can be carried over indefinitely into the future.
For instance, the contribution limit for 2021 is $6,000, if you contribute the whole amount and later in the year, you withdraw $3,000 for an unexpected expense. You aren’t allowed to contribute the $3,000 back within the same year – if you do, it will put your contribution for 2021 at $9,000 and you’ll be charged a penalty on the extra $3,000.
TFSA is a great account to invest in for short-to-medium terms and can be the go-to account for people who earn below $50,000 a year. Ensure you confirm the average rate of returns and administration fees from various financial institutions or investment firms before choosing the one to open your account with, as some give ridiculously low return on investment. Also be sure to ask about the terms and conditions of each financial institution in relation to closing your TFSA account.
Registered Retirement Savings Plan (RRSP)
This investment account lets you contribute 18% of your previous year’s earnings towards your retirement. If you are new to Canada, you are not eligible for RRSP until you have filed your first tax return. Your Notice of Assessment will contain your RRSP contribution limit. RRSP accounts have a contribution cap every year (specific to you and your income). If you don’t use your contribution limit, the balance carries over to the next year – if your RRSP room is $5,000 in 2021 and you were able to contribute $2,000, you will have $3,000 added to your contribution limit in 2022.
RRSPs are tax deductible accounts – the amount you contribute to your RRSP is deducted from your taxable income at the end of the year, thereby reducing the amount of tax you owe or inadvertently increasing your tax return. The money you earn within the RRSP (whatever form of investment it is) will also not be taxed until you make withdrawals after you retire.
You can borrow from your RRSP before you retire under two conditions: for the down payment to purchase a home or for your education. Such withdrawals will be considered a loan that is to be repaid within 15 years.
These factors make RRSP an ideal way to start saving for your first home in Canada – by contributing to your RRSP, you are not only reducing your taxable income, but also saving toward a specific goal.
Keep in Mind:
Many employers in Canada often offer an “RRSP match” as part of your benefits package. This means that you can choose to have the employer directly deposit a percentage of your take-home monthly salary into your RRSP account and they will match that percentage up to a certain amount (e.g: you can choose to have $500 deducted every month to be deposited into your RRSP and the company will match that – $1000 will be the total amount deposited into your account). This is usually an optional benefit, but it is in your best interest to opt-in if your employer offers this benefit.
The first two steps towards financial well-being would be to create a budget and build an emergency fund. After that is when you should start investing – your aim should be to max-out your RRSP and TFSA before moving on to other accounts/investments.
Registered Education Savings Plan (RESP)
This is a tool that can help parents (or well-wishers) – Canadian residents – save for children’s post-secondary education. RESP accounts are created under a child’s Social Insurance Number (SIN) and cannot be transferred, except to a sibling. There is also the added advantage of receiving Government contributions to each RESP under the Canada Education Savings Grant – up to $7,500 per child per account (in a lifetime). Children from low-income families are eligible for a higher amount and additionally, a certain sum from the Canada Learning Bond as well.
Like the other registered accounts, the contribution room in RESPs accrues every year. When a child withdraws from the RESP for their post-secondary education, they are taxed either at 0% or at a minimum. RESPs are not only a great tool for tax-free growth, but also an amazing way to give your children the gift of higher education without the burden of debt that it usually brings with it.
Most of these accounts have penalties attached for contributing over the limit and you alone are responsible to keep track of your limits – you can find these limits printed on your tax returns or on the main page of your CRA account.
Once you understand the function of each of these accounts, you can make choices regarding the actual investments themselves. Ascertain your risk tolerance (high, medium, low), asset allocation (type of investments you’d prefer such as ETFs, GICs, bonds, gold, mutual funds, and more recently, cryptocurrency), and the amount of involvement (active/passive investing) you want in the investment process.
Having this information can help you further narrow down the “how” of investing – the options you have range from robo advisors, investment professionals/ mutual fund advisors, banks and online brokers. Each of these have their advantages and disadvantages. Once you’ve determined all the factors that would be the most optimal for your current income and savings goals, consider automating contributions from every pay cheque to truly set yourself up for success.
Remember, investments bear the most fruit in the long term. Compound interest is financial magic, so don’t wait until you start making a certain amount to start investing – the sooner you start, the higher the benefits no matter how small your initial contributions are.