When I ask people what they are invested in, I generally get two answers: a little bit of everything, or RRSPs. A little bit of everything seems to be a catch all and is a little discerning because it indicates that they’re not entirely sure, and/or that they lack specific investment goals. And RRSPs are not an investment. So let’s back up a bit and see if we can understand all these acronyms.
Registered Retirement Savings Plan (RRSP)
RRSPs are NOT an investment; they are an investment/savings vehicle. Put another way, imagine that you have a box that you are calling RRSPs. You can put investments, such as mutual funds, Guaranteed Investment Certificates (GICs), Exchange Traded Funds (ETFs), company stocks or shares, bonds, or even mortgage loans in this RRSP box of yours. The money that you contribute to RRSPs every year is tax deductible (for every dollar you contribute, your taxable income is reduced by a dollar during the year you make your contribution), and any earnings you receive from your investments are allowed to grow tax free. When you are eligible to retire, any withdrawals from your RRSP are taxed at 100%. Once you put money into your RRSP, and purchase your investments (mutual funds, ETFs, etc.) you are able to buy or sell any of your investments. There is a limit to how much you can contribute every year (18% of your earned income from the previous year up to a designated max), and if you do not make a contribution during the year, you can carry forward that amount and contribute that amount in the future.
My “two cents” on RRSPs:
- DO NOT take out a loan to contribute to a RRSP. Your advisor/banker will advise you to do this to get the tax write off, but it really just pads their pockets. Yes, I know, interest rates are low, get a nice cheque back from government blah blah blah, but no. Sit down with me, and I would <3 to run the numbers with you. An excuse to play with excel? Seriously, it would make my day.
- Instead, figure out how much you want to contribute to a RRSP. Then, set up an ASP (automated savings plan) and have this money withdrawn from your chequing account each month. At the end of the year, you take this lump sum and make your contribution. Or set up an ASP to contribute automatically into a low-cost index mutual fund. This would be the best course of action for most people.
- DO NOT make withdrawals on your RRSP before you retire. The current rules allow you to make tax-free withdrawals if you buy your first home (Home Buyer’s Plan), or want to go back to go back to school (Lifelong Learning Plan). There are rules on how much you can withdraw and how long you have to pay it back, but you are interfering with the magical powers of compounding by doing this, thus sacrificing your future for immediate gratification. If you want to buy a home, save up for the 20% down payment. If you want to go back to school, save up for it.
- It might not make sense to max out your RRSPs every year. The money might be better utilized elsewhere (TFSA or mortgage). This is completely dependent upon your financial situation!
Tax-Free Savings Account (TFSA)
Easily the best thing the government has ever done for us. Honestly. A TFSA is also a savings/investment vehicle (box) that you put investments in. Basically anything you can put into a RRSP, you can also put into a TFSA. Beginning January 1, 2009, anyone over the age of 18 can contribute $5,000 a year into their TFSA, and all the earnings can grow tax free. You can withdraw the money any time you want, and re-contribute the amount you withdrew as early as the following year! The best part? All withdrawals are taxed at 0%. That’s right. 0%!
My “two cents” on TFSAs:
- Everyone should be taking advantage of this gift from the government! As of January 1, 2012, you would be able to contribute up to $20,000 per person (assuming you haven’t made any contributions before).
- If you are saving for a car or a downpayment or a vacation, it might be better to shelter that money in here. Even with the awesomeness that is the ING Direct or PCF savings accounts, the government will be taking their cut of any interest you earn.
- Perfect for retirement savings as well! When you retire, withdrawals from RRSPs will be counted towards your income for the year and taxed accordingly. The income may affect your eligibility for Old Age Security (OAS) or Guaranteed Income Supplement (GIS). Not so with money from TFSAs!
Final Question of the night: If you retire with a million dollars, would you want it in a RRSP, or in a TFSA?
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