Everyone knows the importance of finding a great wealth manager. In order to take full advantage of your investments you also need to understand the different Canadian investment accounts. In Canada, there are several types of investment accounts that investors can open, each with different characteristics and features. Broadly, we can categorize these as registered and non-registered accounts. Let’s begin by discussing non-registered accounts first, and then transition into looking at the various registered options available. At any time, you would like to check contribution amounts for any specific registered account. You can find this on the Government of Canada website, by clicking here.
The Non-Registered Account: The Most Flexible Account
Non-registered accounts are the “basic” account that you can open at almost any financial institution. There is no limit to how much money you can add to or withdraw from a non-registered account. When opening a brokerage account, the basic investment account, you have the option of choosing a full-service or discount brokerage. Discount brokerages offer no investment advice – you, as the investor, make all investment decisions. With full-service brokerages, you will have access to “a wide array of services and products. This includes financial and retirement planning, investing and tax advice and regular portfolio updates.” The drawback to having these additional features is the additional annual cost, which is roughly 1-2% of your portfolio value.
Treatment of Taxes for Investment Accounts
In a non-registered account, tax at your marginal rate applies as interest income. However, dividends and capital gains are separate. Dividends are subject to special taxation, which involves adjustments to the final amount as well as a dividend tax credit. As a result of this, dividends are taxed at a lower rate than income. Capital gains are calculated on a net basis. Calculate all of the capital gains and losses in your account, net the amount, and pay taxes on 50% of this amount. Before opening a non-registered ensure that you have maximized your TFSA room that is still available (more on this below).
Registered Investment Accounts: TFSA, RRSP, and RRIF
1. Tax-Free Saving Account (TFSA)
The TFSA, which Canada launched in 2009, is a registered account. All investment gains are tax-free, even when withdrawn from the account. To open a TFSA, you must be at least 18 years of age and have a valid Canadian social insurance number. Contributions to the TFSA account a limit of $5,500 per year (the current year contribution limit). The Lifetime limit is $57,500 (the current cumulative contribution limit). Since gains from a TFSA are not taxed, losses also can’t be used to offset gains in other accounts (a strategy called “tax-loss harvesting”). Regarding withdrawals from the account, “you never lose your contribution room [and] can recontribute amounts you have withdrawn. [Investors] have to wait until the next year to recontribute, but can carry forward the re-contribution room indefinitely.”
2. Registered Retirement Savings Plan (RRSP)
The RRSP (Registered Retirement Savings Plan) is another type of registered account that can offer tax benefits. The requirements to open an RRSP are simple. You must be under 69 years of age, have available contribution room, and file income taxes with the Canadian Government. Once eligible, you have the option of opening a self-directed (discount), or managed (full service) account. This decision is based on your comfort with investing. In a managed RRSP, “whoever is responsible for managing the investments in your account will make all the necessary investment decisions on your behalf.”3 Alternatively, you can “elect to manage your retirement assets yourself and choose a self-directed RRSP.”3 The RRSP account is similar to the TFSA account. A specific contribution limit is set each year, which can accumulate. Contributions to an RRSP account for the current tax year can be made until March 1st of the following year.
The benefits of an RRSP account are significant. Contributions allow you to reduce your income tax in a specific year. In addition to this, investments in your RRSP grow tax-free (until you withdraw them from the account). Where the RRSP falls short of the TFSA is when it comes to withdrawals from the account. Generally, a withholding tax is applicable when taking money out for any reason. The exceptions are retirement, post-secondary expenses, or the purchase of a new home. Early withdrawals also reduce your contribution room by the amount of the withdrawal. Exceptions such as the Home Buyer’s Plan (HBP) and Lifelong Learning Plan (LLP), will be discussed in in future articles.
3. Registered Retirement Income Fund (RRIF)
Once you are ready to retire, you turn your RRSP into an RRIF (Registered Retirement Income Fund). At this point, you can no longer contribute to it. The RRSP to RRIF conversion occurs automatically at 71 years of age. Withdrawals that must begin, at the latest, at age 72. The RRIF forces you to withdraw a minimum amount per year relative to your age (minimum withdrawal formula can be found here). Tax is applicable to this minimum amount as income at your marginal tax rate. Amounts greater than the minimum will face the same withholding taxes as early withdrawals from an RRSP. The minimum is based on hypothetical figures, (similar to the 4% withdrawal rule), which should allow for your savings to last throughout your retirement. This also allows the government to recover the taxes that you have deferred. The logic behind saving early within an RRSP is that you will withdraw the money at a much older age when you will be in a lower tax bracket.
Other Registered Investment Accounts: RESP, LIRA/LIF
Several other account types will be in review as Part Two of the series. To continue learning about Canadian registered investment accounts click here.