So many choices for your savings
Saving is boring. Putting money aside for the future detracts from our ability to spend today, and the rewards of saving are delayed. Human nature prefers immediate gratification, and saving money for the future doesn’t provide this. As a result, some incentives are helpful.
Enter government-sponsored savings plan. These plans were introduced to make it more rewarding to save for all kinds of things like retirement, education, and a home. To incentivize people to save, the government asked itself: “What do Canadians likes more than almost anything?” Since a savings account can’t come with a $10 Tim Horton’s gift card, the government chose the next best incentive: lower income tax.
The various savings plans available to Canadians are relatively new. The RRSP was introduced in 1957 to encourage people without company pensions to save for retirement. Since then, new accounts have been added to the roster: RESP (1974), RDSP (2007), TFSA (2009) and FHSA (2023).
It’s probably accurate to say that everyone likes the idea of the up-front tax break of an RRSP, yet only about 22% of Canadians who file taxes contribute to one. There are many reasons for this lack of take-up: low income, inability to save, and distrust of anything related to the government all come to mind. However, I suspect a significant reason is that people are confused, uninterested, and paralyzed by indecision.
I’ll bet that you first learned about RRSPs at your bank. Despite my mild cynicism about banks and RRSPs, I do think that the bank branch promotion of RRSPs to client has been important for encouraging adoption – it’s a great start. But as a Canadian who needs to save for retirement (and that’s most of us), you would benefit from going a little further than just opening an RRSP at the branch. Taking the time to learn about all of the accounts and what options are available to you besides just having one at your bank branch will be well worth the time and effort.
Yes, it can all seem complicated and frustrating, but with a tiny bit of reading and learning, you’ll see that using these accounts to your advantage is actually quite easy. Don’t get tangled up in the acronyms, rules, and tax implications. Start simply by evaluating which accounts are right for you based on your savings goal. Then you can do a deeper dive to learn more and optimize the opportunity.
Choosing the right accounts
TFSA: Let’s start with the account that wins the Most Valuable Player award - the TFSA. A tax-free savings account makes sense for anyone who pays income taxes and wants to save money for a future goal. The TFSA is good for any kind of savings, whether it’s short-term or long-term. This is because you can easily move money in and out of the account without penalties or tax implications. It’s totally flexible. The TFSA can be used in conjunction with other account types to top up your savings. Your TFSA money doesn’t have to be earmarked for anything specifically – you might end up using it to buy a new car, the pay your child’s tuition in fourth year, or dip into it for an exceptional vacation when you retire. Make sure that the TFSA is on your team.
RRSP: The registered retirement savings plan is just as it sounds - a plan for saving for retirement. This is not a plan for other savings goal. Yes, you can take money out for other reasons like buying a house or going back to school, but the main purpose is retirement. Here’s the thing though: it’s not for everyone. The main benefit of an RRSP is that you get a tax break now (when you put money into it), which is great. But when you take money out later in life, you will pay income tax on it just like it’s regular income you earned from a job. Therefore, the important question is this: is your tax rate higher today than it will be in the future when you withdraw the money? Or more simply, are you earning more income today than you will be when you’re retired? For most people, the answer is yes, especially as they get older and start earning more money at work. But it’s not true for everyone. Very generally, if you are earning $45,000 a year or more and are paying income tax on these earnings, an RRSP probably makes sense for you. (Please don’t base your decision to contribute solely on this guideline – it’s just a starting point for further analysis.) But if you are making less, you might be better off maximizing other accounts first.
RESP: Anyone who wants to save for their child’s education after high school benefits from the registered education savings plan. This is partially for tax reasons, but mostly because of the government contributions. On the tax front, the benefit comes from the fact that when the money is taken out of the RESP to pay for school, the student is liable for the income taxes payable on the money that was earned in the plan, not the parent. And of course, the student will have a very low tax rate (possibly even a 0% tax rate). Even more of a no-brainer though is the money the government kicks in: you’ll get a 20% match on whatever you put in to the account up to a maximum of $500 per year per child. All you need to do it find $2,500 to get the $500 every year. No strings attached!
RDSP: The registered disability savings plan is meant for people who have a long-term disability that will make it hard for them to support themselves financially. Like the RESP, the government contributes to the plan alongside the plan holder and the amounts are generous. To qualify, you’ll need a doctor to fill in some forms indicating that the person who is benefitting from the account has a disability that qualifies them for the plan (and the Disability Tax Credit). You can open this plan on behalf of someone else and anyone can contribute to it. It’s a great way for friends and family members to rally around and support a disabled loved one.
FHSA: The first home savings account is the newest addition to the team. Introduced just this year, the FHSA is a must-have for anyone who qualifies as a first-time home buyer and thinks they might buy a home sometime in the next 15 years. The FHSA has the best qualities of an RRSP and a TFSA: you get an up-front tax break like an RRSP and, like a TFSA, you won’t pay any tax when you take the money out. If you don’t end up buying a home, no problem: you can roll the money into an RRSP. So even if you’re not sure whether you will buy a home, go ahead and get yourself a FHSA.
Mix and match
In my experience, many people have at least two or three of these accounts – sometimes more. Since each serves a purpose, it totally makes sense to do this. Use whatever you can to maximize your money. And don’t stress about making a mistake – there are few significantly negative impacts of choosing the “wrong” account.
Deciding which accounts are right for you is an important first step – but it’s just the first one. You also need to decide where to open these accounts and importantly, what kinds of investments to hold in these accounts. Remember, a TFSA isn’t an investment – it’s an account. Think of it like a bucket: your TFSA bucket can hold GICs, mutual funds, stocks, ETFs and plain old cash. Ditto for all of the other accounts. An RRSP is a bucket. An RESP is a bucket. Don’t let your money simply sit there – invest it.
You can read more details about these account on my website and on my blog. In the coming weeks I’ll be diving into some additional details to help you make good decisions. In the meantime, feel free to leave a comment or email me with your questions.