It’s the time of year when Canadians are thinking about where they might put some money to work for them, as various government-sponsored, registered accounts reset their contribution limits in January. Registered accounts are accounts that are tracked by the CRA (Canada Revenue Agency). Today, in Canada, there are 4 registered account options for investing money long term towards your future goals. For some, this may be saving towards an appreciable asset (like a house), a depreciable asset (like a new car), your retirement, or your children’s education. The government has created these tax-efficient accounts for you to utlilize towards your savings goals. All these accounts are slighlty different in terms of present and future taxation, and using them correctly towards your short and long term savings goals is important.
The 4 different government savings accounts include RRSPs (registered retirement savings plans, TFSAs (tax-free savings accounts), and FHSA (first home savings account), and RESPs (registered education savings plan). The FHSA is a new account first introduced in April 2023. Each of these accounts is slightly different and I’ll try to explain their major differences below.
RRSP (registered retirement savings plan)
An RRSP is an account where you can save money and the tax is deferred until it is withdrawn. You may choose to invest the cash you save in fixed income or market investments, and any gains you make grow tax-free until you withdraw them. When it is withdrawn, it will be taxed at your marginal tax rate based on your total, annual income. The premise of this account is that you will not withdraw the money until retirement, when your income needs are smaller, therefore your taxation is less. The amount you can contribute into an RRSP is determined through a CRA calculation based on your prior years income and a deemed pension credit, if applicable, from your employer. A notice is sent out annually to Canadians informing them on their RRSP limits, and can be found on the myCRA website. You do not want to overcontribute, as there are penalties, and if you undercontribute, unused balances are carried forward to use in future years. Another key benefit of this account is that any contribution you make is applied against your current years’ income at tax time, and reduces your income by the amount you contribute. This effectively eliminates income tax by your marginal tax rate in that year, and might provide you a tax return versus a tax bill. RRSPs are a great tool for high income earners or households with extra cash to invest towards retirement.
TFSA (tax-free savings account)
A TFSA is an account where you can contribute money and invest it, and anything you make is completely tax-free on withdrawal. The annual limits have changed over the years since they were started in 1995. The new contribution limit for 2024 is $7000 per person, versus $6500 per person in 2023. These accounts also have a lifetime limit, which is essentially a total of the annual contribution limits since inception. The current lifetime limit is $95,000 for 2024. The lifetime limit grows annually based on the aggregate, annual contribution limits since 1995. What this means is if you haven't taken advantage of your full annual limits every year, and for example, only put in $40,000 up til 2024, you still have $55,000 worth of room to utilize and can do this in one lump sum if you choose. However, you are not eligible to start accumulating towards the lifetime limit until you are born. Therefore, anyone born in years after 1995 will have a reduced eligibility based on their years in the program. You need to track any unutilized room yourself, and any overcontributions will have interest penalties from the CRA. Arguably, these accounts are a better place for people to use up room first, however as both a disadvantage and advantage, using them is more flexible than an RRSP as there are no tax implications to discourage you. If you can contribute money into them, invest wisely, and leave it alone, they are great vehicles towards growing your money. These accounts, arguably, should be utlized first by lower income households before putting money into an RRSP. This is because lower income households do not pay much tax already, so an RRSP has less of a tax-reducing effect from their investment. Plus, lower income households usually have limited savings to use all the government account contribution limits together, so need to pick and choose what’s best to do first.
FHSA (first home savings account)
This registered account, first introduced and contributions allowed in 2023, has benefits that allow investors to purchase their first home. In 2022 the government approved this registered account for 2023, with an annual contribution limit of $8000 in addition to a $40,000 lifetime limit. You can carry forward any unused contributions to the next year. So if you only put in $5000 this year, you can add $3000 to the limit in the following year and contribute $11,000 in 2025. But important to know, your contribution allowances will not begin until you open an FHSA account. So, if you only start your contribution limits in 2024, you cannot add on the 2023 $8000 limit. Once you get started, you can keep contributing to the lifetime limit of $40,000. The FSHA has the benefits of an RRSP and TFSA rolled into one. The amount you contribute is applied against your annual income to reduce your taxes, plus any gains from investments held inside the account are completely tax-free! It has the benefits of both worlds with one exception. It must be used to purchase your first home to incur the benefits. One other thing to consider is, once you open an FHSA, it allows a maximum of 15 years before it must be used. If no house is purchased, it can be rolled over into an RRSP if there is enough contribution room available. Otherwise it will be included in income and taxed at your marginal rate (i.e. tax rate on the additional income).
RESP (registered education savings plan)
An RESP allows you to contribute and invest towards a post-secondary education. Anyone can open an RESP for their children, themselves, or for anyone else. The gist of an RESP, is you can contribute into it, invest and enjoy tax-deferred gains, and upon withdrawal for educational purposes, it is taxed in your a student’s hands and at usually a lower tax rate. Contribution are not tax deductible, however any investment gains grow tax-free until they are withdrawn. One unique benefits of an RESP, is they have a lifetime limit per individual 0f $50,000 and you can contribute in any amount you want at any time after an account is opened. Further benefits to the RESP, is there is a Canada Educational Savings Grant (CESG) and a Canada Learning Bond (CLB) available to account holders and beneficiaries. The CESG matches any annual contributions up to$500, while the CLB is $500 bond available to low income families the year it is opened, then $100/yr for every year thereafter as long as they continue to qualify. You must make a minimum contribution when you open the plan. You can have a family plan (multiple beneficiaries) or an individual plan (one beneficiary). One thing to note, however, if it is not utlized for edcational purposes within 36 years of opening it, it must be withdrawn. And in most instances of this nature, the account will collapse and be taxed in the hands of the person who started it.
As you can see, each of these Canadian registered accounts provides benefits to the users in 3 specific areas.
Tax reduction - your income tax is reduced by contributing.
Tax deferral - you dont pay income tax until withdrawal.
Tax elimination - you don’t pay any tax on gains.
An RESP does 2, RRSP does 1 and 2, a TFSA does 1 and 3, and a FHSA does 1,2, and 3. Your income, available savings, and your savings goals and tax situations will determine if you use any or all of these accounts, but utilizing them in some capacity and/or some combination is a no-brainer!!
You should at least open these accounts with your financial institution, make any minimum contributions, even if there is no investments in them; be it a bank, mutual fund company, brokerage, or otherwise. Then they are there readily available when and if you choose to use them, and your FHSA starts growing the allowable annual contribution limits towards the lifetime maximum.
In my humble opinion, an FHSA is the most beneficial of all accounts to people savings towards first home ownership due to the combined tax-free and tax-deductible benefits. Once this is achieved, or your annual FHSA limit is satisfied, a TFSA is the next best vehicle to park money due to it’s completely tax-free structure and flexibility for withdrawals. If you are a high income earner, and/or DINK (double income-no kids) couple and thrifty, it’s likely you have extra money laying around and should maximize your RRSP contributions next. RRSPs are beneficial in terms of reducing your taxes (tax deductible) and tax deferral qualities (putting off tax til your income situation drops and you take money out in your retirement years).
All these accounts have their own unique structuring and benefits, and in a perfect world, you should completely maximize the effect of all of them. In the real world, it is likely you will have to sort your priorities out and focus and invest into one, a bit into some, or a bit into all of them. You’ll have to assess and choose.
PS - for my USA friends, … they have American versions of these.