Hello everyone, I’m Johnny. Today, I’d like to talk to you about RRSP and TFSA.
Are you familiar with the terms RRSP and TFSA? You’ve probably heard these terms in various places. Many of you might have already invested in them. However, not many people seem to know exactly what they are investing in. One of the most common questions I receive is “How much should I invest in RRSP?” To summarize, RRSP and TFSA are not investments themselves but rather savings or investment vehicles registered with the Canada Revenue Agency (CRA). Think of them as empty shells where you can fill in various investment products, and the CRA provides tax benefits accordingly.
First, to understand RRSP and TFSA in depth, you need to understand Canada’s taxation systems. You might have heard that taxes in Canada are high, right? You might have heard people complaining, “Ugh… I’m paying half of my income in taxes…” Well, that’s partially true. Canada has a Progressive Tax System, where tax rates increase as income levels rise.
Let’s pause here for a moment and look at the chart above. As you can see in the chart, tax rates start at 20.05% for income up to $51,446, then increase gradually, reaching up to 53.53%. However, the 53.53% tax rate doesn’t apply to your entire income. That’s why Canada uses terms like marginal tax rate and average tax rate to describe taxation more accurately.
There’s another important tax to consider: Capital Gain Tax (CGT). It’s a tax on profits made from selling assets, but it’s not as simple as just taxing 50% (It is proposed to increase to 2/3 above $250,000 for individual in June 2024) of the gains. For example, if you invest $100 and make a profit of $50, only $25 of that profit is subject to your marginal tax rate. Capital Gain Tax rate is an inclusion rate.
Now that you understand Canada’s tax system, let’s delve deeper into RRSP and TFSA. RRSP stands for Registered Retirement Savings Account, designed for retirement savings or investments with tax benefits. One crucial point is that taxes are deferred. Taxes are only levied when you withdraw the money, ideally during retirement when your tax rate is lower. There’s also an advantage for certain tax years where RRSP contributions can lower your taxable income, particularly beneficial for self-employed individuals. However, RRSP has limitations such as contribution limits based on income and restrictions on withdrawals.
Now, what about TFSA? It stands for Tax-Free Savings Account, where investments grow tax-free, and you can withdraw funds at any time without penalties. However, contributions to TFSA are not tax-deductible in the year they are made. The contribution limit for 2024 is $7,000, and any unused contribution room carries forward indefinitely. Be cautious not to over-contribute, as a 1% penalty per month applies.
So, which one is better? Generally, many will tell you to maximize TFSA contributions before starting RRSP investments is recommended. Why? Because TFSA offers tax-free growth, while RRSP provides tax deferral. But remember, investment decisions depend on individual circumstances.
When planning savings or investments, consider three factors: Investment Goal, Time Horizon, and Investment Need. Set realistic goals aligned with your financial situation, understand when you’ll need the money, and choose investments accordingly. It is important to remember that there are no cookie cutter solutions for any investment strategy.
Now, let’s talk about the investment options for RRSP and TFSA. Both accounts allow investments in cash, mutual funds, securities, GICs, bonds, and certain shares of small business corporations. The eligible investments are listed on CRA’s website: https://www.canada.ca/en/revenue-agency/services/tax/technical-information/income-tax/income-tax-folios-index/series-3-property-investments-savings-plans/series-3-property-investments-savings-plan-folio-10-registered-plans-individuals/income-tax-folio-s3-f10-c1-qualified-investments-rrsps-resps-rrifs-rdsps-tfsas.html
You can transfer funds from RRSP to TFSA but be aware of the tax implications. Additionally, there’s a new option called FHSA (First Home Savings Account), like RRSP but designed for first-time homebuyers.
I truly hope this information has been useful for you. If you ever need any professional guidance, please don’t hesitate to get in touch. I’d be more than happy to assist you in making the best investment choices.
Johnny Choe