Just as it’s important to select the right type and mix of investment products (e.g. cash equivalencies, fixed income securities, equities and investment funds) to meet your financial goals, so too is choosing the appropriate type of account to hold them in. Understanding the different types of accounts available to you can help you maximize your gains and reduce the amount of income taxes you owe.
You can use several types of investment accounts in Canada that are broadly categorized as either “registered” and “non-registered”.
Non-Registered Investment Accounts
Non-registered investment accounts are the most flexible, with no restrictions on how much you can contribute or withdraw. They can be opened at any financial institution or registered firm.
Interest income in a non-registered account is fully taxed at your marginal tax rate, with some special considerations for dividends and capital gains. Dividends are taxed based on the province you live in, while capital gains and losses are calculated on a net basis with taxes at your marginal rate paid on 50 per cent of its value. While this account may seem like a logical first step for new investors, it’s worth understanding the benefits and characteristics of registered accounts before opening a non-registered account. In order to learn more about the different investing accounts available to Canadians, visit CheckFirst.ca and the Government of Canada website.
Registered Investment Accounts
Tax-Free Saving Accounts (TFSAs)
TFSAs, launched in 2009, have unique features that allow you to shelter your investment gains from most taxes. Without the tax implications found in a non-registered account, investment gains in most cases can be fully realized once withdrawn. As a result, TFSAs are becoming increasingly popular among Canadians.
Another unique feature of TFSAs is the contribution room limit. Every year the Canadian government provides additional contribution room to all Canadians. If you were 18 or older in 2009, you are eligible to contribute the full amount of $75,500; if you were younger than 18 in 2009, your contribution room would have started when you turned 18. For the 2021 tax year, every Canadian 18 and older received an additional $6,000 contribution limit in their TFSA. It’s important that you don’t over contribute to your TFSA however, as the excess amount will be subject to a one per cent per month penalty tax.
Registered Retirement Savings Accounts (RRSP)
RRSPs were introduced to Canadians over 60 years ago in order to encourage and reward them for building a nest egg for retirement. By using them strategically, they can benefit you now and in your retirement. For example, contributions you make to your RRSP allow you to reduce your income tax in a specific year by your marginal tax rate applied to your contribution and, if contributions are invested, can even grow tax-free. Additionally, you can use the money in the RRSP account to purchase or build a first home (Home Buyers Plan) and for post-secondary expenses (Lifelong Learning Plan) tax-free if paid back within 15 years. Once you retire, any withdrawals from your RRSP will be taxed at your retired tax bracket, which in theory should be lower than when you contributed during your working years.
While an RRSP can help you grow your wealth for retirement, special rules do apply. You may only contribute up to 18 per cent of your earned income from the previous year, and if you withdraw funds from the account early, immediate withholding tax is applied and your contribution room is permanently reduced. Once you reach 71, your RRSP is automatically converted to a Registered Retirement Income Fund (RRIF) and you can no longer contribute to the account. Instead, you must withdraw a calculated amount each month, which will be taxed at your marginal tax rate. If you withdraw more than the allotted amount, you will be subject to the same withholding taxes as if withdrawn prior to retirement.
When it comes to investing, where you invest is just as important as what you invest in. With a better understanding of the different accounts and their unique benefits and downsides, you may find that one or a mix of different types of accounts can help you better realize your financial goals and grow your wealth for retirement.