We’ve discussed the importance of finding a great wealth manager. Overall, wealth managers with fiduciary responsibilities keep their focus on serving their clients as individuals, rather than just as another source of capital. That said, as an investor, it’s also important for you to understand the various Canadian investment accounts.
Knowledge really is power. And when you’re an informed investor, you can make better decisions for your money. 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 start by taking a quick look at non-registered accounts first, and then explore the various registered options available.
Table of contents
What is a non-registered investment account?
Non-registered accounts are the most “basic” accounts 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 (i.e. what is considered a basic investment account), you’ll choose either 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 full slate of several services and products, including financial planning, retirement planning, investing and tax advice, and portfolio updates.
While extra services are great — especially if you’re looking for a bit of assistance — the additional annual cost is a drawback. This works out to roughly 1-2% of your portfolio value.
Related Reading: When Should I Hire A Wealth Manager?
Registered vs. non-registered accounts
The biggest difference between registered and non-registered Canadian investment accounts is that the former are tax-free. Registered accounts are essentially tax shelters, allowing your money to grow. Taxes only come into play when you withdraw your money — either ahead of time (which might also involve extra penalties) or when you retire and need income. The exception here is with TFSAs, but more on that below.
Another difference is that while registered accounts have contribution limits, the sky’s the limit with non-registered options.
Non-registered accounts, while offering a degree of flexibility, don’t offer the same incentives — both tax-wise and those listed above.
Taxes for Investment Accounts
In a non-registered account, your investments are subject to tax. At the same time, depending on the type, this investment income can be taxed in different ways/rates.
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.
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Canadian Registered Investment Accounts: TFSA, RRSP, and RRIF
Below we cover the details of the core registered investment accounts in Canada, including the TFSA, RRSP and RRIF. Keep reading to learn more about each and their unique features.
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.
The contribution limit to your TFSA account is $6,000 for the 2021 tax year. Never contributed to a TFSA? That limit is $75,500. Any amount of money you withdraw is added to the amount you are allowed to contribute the next year. For example, let’s say that next year the limit will also be $6,000. If you invested $6,000 this year, but then took out $500, next year you will be able to contribute $6,500
Since gains from a TFSA are not taxed, losses can’t be used to offset gains in other accounts (a strategy called “tax-loss harvesting“).
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2. Registered Retirement Savings Plan (RRSP)
The RRSP (Registered Retirement Savings Plan) is one of the most well-known registered accounts offered in Canada. It’s also the most popular savings vehicle for retirement.
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. As mentioned above, it comes down to whether you want the features and services that come with a professional handling your account.
An RRSP account is similar to a TFSA account. Every year, a contribution limit is set. 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. For starters, contributions allow you to reduce your income tax in a specific year. Second, 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.
3. Registered Retirement Income Fund (RRIF)
Once you are ready to retire, you’ll convert your RRSP into an RRIF (Registered Retirement Income Fund). RRIFs, like the name suggests, give you a steady (taxable) income in retirement. Your money continues growing tax-free (like your RRSP), and you can invest the funds in a similar way.
While you can make this conversion anytime, you’re required to do so no later than December 31 of the year you turn 71. Withdrawals (i.e. your retirement income) must begin, at the latest, at age 72. One important thing to note about RRIFs is that you are required to withdraw a minimum amount per year, relative to your age. The formula for your minimum payout is 1÷(90 – your current age). That said, the account does come with a degree of flexibility with payment amount and frequency.
Amounts greater than the minimum will face the same withholding taxes as early withdrawals from an RRSP. Remember: 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.
Related Reading: How to Move from Self-Directed Investing to Managed Investing
Other Registered Investment Accounts: RESP, LIRA/LIF
In Part Two of this series, we’ll continue by outlining RESPs, LIRAs, and LIFs — all types of Canadian registered investment accounts.
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