The idea of making your money work for you sounds pretty interesting, but you need to know how to do it with as little costs as possible, and that’s where tax-advantaged accounts come into play.
Tax-advantaged accounts are accounts introduced by the Government of Canada to help folks save and invest with tax benefits. The account can either be exempt from tax or defer the tax to a later date in the future.
Now let’s get down to the acronyms. TFSA, RRSP, RESP, and RDSP, what do they all mean, and when should you be thinking about using each one?
When to use each
Firstly, when considering what account to invest in, you need to think closely about your financial goals.
If you're simply looking for a tax-free account for your general investments, you might want to try The TFSA or Tax-Free Savings Account which is a much more flexible investment account since taking money out of it has no tax consequences. A TFSA can do more than just save, it can hold investments such as , , etc. Use a TFSA for long-term or short-term and saving for big-ticket items like a car or house, that you want to be able to access in your time of need.
Use the RESP or Registered Education Savings Plan if you plan to save for with tax advantages, and enjoy the various benefits you can access if depending on your household income. With this account, tax is not paid while the money is in the account. Tax is only paid when the student or needs to withdraw it from the account meaning they would be paying little to no tax since the student will most likely be in a lower income bracket.
If you’re saving specifically for your retirement, your income is on the higher side, and you don't need to access the money till you say goodbye to your working days, then an RRSP or Registered Retirement Savings Plan might be just what you need. This account is not tax-exempt like the TFSA but it’s a tax-advantaged account because you would avoid paying tax during the year when the contribution into the RRSP was made and would only have to pay income taxes much later when you withdraw it after retirement.
However, a person with a disability from a low-income household will reap more benefits by using an RDSP or a Registered Disability Savings Plan to save for their retirement as the Federal government will match deposits by up to 300%, up to $70,000 to incentivize contributions.
“You have done a great job of paying your taxes and saving up. As an incentive I will let you invest in a room called TFSA and never tax you for any growth within it as I have already taxed you on it..”
The earnings you make in your TFSA are completely tax-free, making it a great incentive for saving and maximizing the income you get, and there are also fewer withdrawal rules associated with this account as opposed to the accounts such as the RRSP.
However, this account type has something called contribution room which is the Government mandated limit you can contribute to your TFSA each year. This limit starts building up once the account holder turns 18. You can find out more about each year’s contribution room here.
The TFSA could also be a better option to save for retirement if your income is less than $50,000. There are a few reasons why financial planners recommend a TFSA for low-income earners, starting with the fact that a TFSA isn’t conditionally linked to your income. Everybody gets essentially the same contribution room that keeps growing each year, starting when they turn 18. So you’re not limited by that 18% rule that governs RRSPs.
If you save for your future retirement, the government will not tax you on the income you make today and instead let it grow tax free until you retire. When you take that income out later, when you retire, you will be taxed on that withdrawal as if it was your current income.
The RRSP has a deduction limit that is fixed at a maximum of 18% of your annual income. You're allowed to claim a tax deduction each year on your annual income for your RRSP contribution. SO! If you make more than $50,000, you’ll get more benefits by saving for your retirement in an RRSP since you generally expect to be in a lower income bracket after retirement when you would actually need the money. Say what? Essentially you will be paying less tax than you would have when you first put the money in the RRSP.
While an RRSP is a great account for retirement, an RESP is excellent for a young person planning for post-secondary education, and the great thing about this account is you can use it to access various government benefits such as the Canada Learning Bond, which is an up to $2,000 dollar Government benefit available FREE of charge to youths from low-income families. You can find out more about this spectacular benefit here. You need to use an RESP to fund post-secondary education. You also need to show proof of enrollment to access the funds in an RESP and also get grants from the government.
The RDSP is also one of those accounts that is tied to a specific situation. Unlike the RRSP, only people with disabilities can be beneficiaries of this account. The RDSP is also tax-deferred in the sense that the earnings on contributions and government grants will only be taxed after retirement when the money is withdrawn. The RDSP has a lot of withdrawal rules, so be sure to review the Government of Canada’s website before opening and contributing to this account.
How to pick a provider
Before you sign up carefully consider which financial service provider you will trust with your money (Providers are financial institutions like or online providers who will open the account).
Different investment brokers will charge different fees. Is the provider planning to invest you into a high-cost mutual fund where they get to charge you a commission, or will they invest your money into low-cost and diversified index funds that grow with the market? Transparency is key, and it's a great idea to sit down with an advisor to discuss their investment strategy before committing to an account.