Here in Canada, we pay no shortage of tax. On our income, we pay anywhere from 25%-50% (depending on income and province), and on our purchases we pay 5%-15%. There’s also taxation on capital gains, dividends, and more. Regardless of your feelings on taxes and government spending, I think we can all agree that we would like to keep more of our hard earned money. In this article, I will introduce you to some of the tools to help you keep more of your money, using registered accounts. I will be covering the basics of Registered Retirement Savings Plan (RRSPs), Tax-Free Savings Accounts (TFSAs), Registered Education Savings Plans (RESPs), and the First Home Savings Accounts (FHSAs).
What are Registered Accounts?
Registered accounts are tools provided by the Canadian government that allow you to avoid taxes legally. That’s right, they allow you to reduce the tax you pay, and put more money in your pocket. Basically, they are buckets that allow you to hold different types of assets. Therefore these accounts allow you to deposit and invest money, and pay less tax on the gains made. Now in exchange for letting you legally avoid taxes, the government puts certain restrictions on what types of assets can be put in to these accounts, and how much you can contribute.
Main Types
There are four main types of accounts provided by the Canadian Government: RRSPs, TFSAs, RESPs, and FHSAs:
- RRSPs are used to save for retirement. They allow you to defer tax from your working years to your retirement years. The biggest advantage is that when you fund an RRSP, the government doesn’t tax those contributions, but instead taxes the money when you use it to fund your retirement. Though there are benefits of RRSPs, they are very restricted in when you can withdraw and use the money. Namely, the funds can be withdrawn for retirement income, or for purchasing your first home (with restrictions). More about RRSPs here.
- TFSAs are the most flexible of the registered accounts. You can use a TFSA to save for any purpose. With TFSAs, you fund them with taxed dollars, however any gains or income made on that money is non-taxable. However unlike the other accounts, you can also take money out of TFSAs without taxation or restriction. More about TFSAs here.
- RESPs are used to save for post secondary education for your children. RESPs are funded with taxed dollars, but any gains are not taxable until they are withdrawn by the beneficiary. Typically student’s have little to no income, so the tax paid on this money is reduced. They also provide additional bonuses on money you contribute ($500 when you deposit $2,500 or more, annually). More about RESPs here.
- FHSAs are used to save for your first home. These accounts are only useful if you are a first-time home buyer (see the definition here). Similar to RRSPs, the contributions are are also un-taxed. The gains made are also un-taxed. Now the key restriction with these is that the money can only be used to buy or build a home. More about FHSAs here.
Comparing Registered Accounts to Non-Registered
Now that we have the basics of the accounts, let’s compare the performance, showing you why you need to taking advantage of these accounts, and using them for investing (see investing strategies here). First, let’s imagine you made $10,000 dollars in income, and you want to invest this income using the different accounts. For this example, you pay the tax on this income (assuming 25% where applicable), then invest it, with an annual growth rate of 8%. Now, let’s see a simplified summary of the results for the various accounts:
| Account | Deposit Amount | Year 1 | Year 5 | Year 10 | Year 20 | Year 30 | Year 40 |
|---|---|---|---|---|---|---|---|
| Tax-Deductible Contributions (RRSP & FHSA) | $10,000.00 | $10,800.00 | $14,693.28 | $21,589.25 | $46,609.57 | $100,626.57 | $217,245.21 |
| No Tax on Growth (RESP & TFSA) | $7,500.00 | $8,100.00 | $11,019.96 | $16,191.94 | $34,957.18 | $75,469.93 | $162,933.91 |
| Un-Registered Account | $8,000.00 | $8,025.00 | $10,519.14 | $14,753.64 | $29,022.63 | $57,091.91 | $112,308.43 |
As you can see in this simplified example, all of the registered accounts drastically outperformed the un-registered account. And this outperformance is even more drastic with a longer time frame or with greater funding levels (hundreds of thousands of difference – think about the effect this could have on your wealth).
Which Registered Account is Right for you
Here’s a simplified guide to which account you can use when:
Now there’s a lot more to it than this but this can give you a quick idea of where to look first. Also, If you want to know how to allocate your savings across different assets here’s my recommendations:
In conclusion, registered accounts are a key tool in building your wealth, and reducing your financial stress. With that said, there are restrictions to how these accounts can be used however, and the penalties for misusing them can be severe. It’s important to understand these restrictions and evaluate your own financial situation to see what account is right for you. Learn more about the accounts here: