Ahhh it’s everyone’s favourite season – Tax season. That’s right, it’s time to get your collective stuff together and report to the government all that wonderful income you’ve made in 2018. I’ve been hearing a lot of talk lately about making contributions to your RRSP (registered retirement savings plan) and Tax Free Savings Accounts or TFSA. I’ve also heard a lot of my friends have weird or false ideas of what exactly an RRSP and TFSA really is and what they are used for. And who wouldn’t be with so much information, jargon and acronyms flying at you around this time of year. I want to share with you what I’ve learned about RRSPs and TFSAs are and why they can help you build your wealth. So lets get started, shall we?

Tax Shelters

What most people don’t know is that taxes is one of the biggest costs you will have in a year, and can be a serious drag on your ability to invest and grow your wealth. Now don’t get me wrong, I believe in everyone paying their fair share of taxes, including me. But the government gives the average Josephine legal opportunities to avoid paying tax both in the now and in the future. One of those tools is the use of “tax shelters”.

“A tax shelter is a vehicle used by taxpayers to minimize or decrease their taxable incomes and, therefore, tax liabilities.” –

Investopedia
Sheltering Your Money From the Financial Elements

If you think about it, the term tax shelter is really an analogy used to describe how your assets can be protected from the nasty financial elements:

Taxes (Click Me!)

Like I said before, taxes can be the biggest expenses you can incur. We all intuitively know this, given that everyone’s favourite pastime is to complain about how much tax they have to pay around this time of year. A tax shelter can help you lower your tax burden and grow your wealth.

Inflation (Click Me!)

Inflation is a common term, but not always clearly defined. The video below gives you an idea of what inflation can do to your savings by reducing your buying power. If you’re saving for retirement, inflation can be a major problem in having enough to meet your needs 10, 20, 30 or 40 years from now. That’s why you need to invest, so you can beat inflation!

That Person in the Mirror (Click Me!)

When it comes to investment savings, you can be your own worst enemy when it comes to stealing from your future self. It’s important to put safeguards to disincentive you from taking money out of your investment savings. A tax shelter may be a good strategy to separate your savings from your day to day spending.

A Tale of Two Tax Shelters

In this post I will be talking about Canada’s two most popular registered tax shelters: Registered Retirement Savings Plans (RRSP) and Tax Free Savings Accounts (TFSA).

RRSPs and TFSA are Not Investments

I want to first talk about what RRSPs and TFSAs are not. When I talk with my friends and family there is a bit of confusion on what exactly RRSPs and TFSAs really are. A common mistake is that people think they are investments. Let me very clear: RRSPs AND TFSAs ARE NOT INVESTMENTS! They are not stocks, bonds, or any type of asset that makes you money. OK….glad I go that off my chest.

Bank Accounts with Special Powers

Instead RRSPs and TFSAs are like a bank account, except for three main difference:

  1. They have special tax sheltering powers
  2. You can purchase and park certain kinds of assets within these tax shelters
  3. They are registered through the Canada Revenue Agency for tracking purposes

What is an RRSP

A Registered Retirement Savings Plan ( RRSP) is simply an account to hold certain type of assets.The purpose of an RRSP is to encourage the general public to save and invest for their retirement.

RRSP Superpowers:

1. Lower Taxes NOW! (Click Me!)

An RRSP has the ability to lower the amount of income you have to report for your taxes. So if you make $50,000 in income and you deposited $5,000 in your RRSP, then the government will only tax you as if you made $45,000. Basically you pay less taxes for saving money. How FIRE is that!!

2. You Can Park Assets in It (Click Me!)

Unlike a regular bank account, an RRSP can hold a number of different kind of assets that grow in value tax free. Below are some examples: Cash savings, Guaranteed Investment Certificates (GICs), Mutual Funds, Stocks, Bonds and my favourite- exchange traded Funds (ETFs).

3. Tax Free Investment Growth (Click Me!)

The second superpower is that when you invest in assets parked in your RRSP account, they can grow/earn money tax free! But don’t get too excited folks. Tax free growth can only happen while you have your savings parked in your RRSP account. If you take the money out, it will get taxed. That’s why it’s important to keep your investment savings in your RRSP for as long as possible, so it can keep growing.

RRSP Kryptonite

RRSPs are great and all, but their powers are not limitless. They have two major weaknesses

Taxed Withdrawals (Click Me!)

RRSPs are pretty sweet when you are putting money in. But if you try to take money out, things tend to get a bit costly. Either way you cut it, you will eventually have to pay taxes when taking money out of your RRSP. It sucks, but you do significantly benefit from the tax free growth over time.

Contribution Limits (Click Me!)

The Government of Canada (GOC) will only all you to squirel so much away in your RRSP. How do you know your limit? It all depends on how much income you make in a year. The GOC allows you to save up to 18% of your reported personal income up to $26,500.

CAUTION: Do not open before retirement!!

Whatever you do, try your best to NOT take money out of your RRSP before retirement. If you do, you will get taxed not just once, but possibly twice. First you’ll pay a withholding tax before you even see the money and second, the money will have to be accounted for as income for that tax year and will be subject to tax. It’s just not worth it, in my humble opinion.

But Wait! There’s More!

Did you know that RRSPs have some hidden lesser known powers? These are called “programs”. They provide you the opportunity to either take money out of your RRSP account to use for a specific purpose without getting taxed, or help your partner build their RRSP.

Home Buyers Plan (Click Me)

If you are a first time home buyer, you can take out $25,000 from your RRSP to purchase your first home. Ah, but there are strings attached. The money you take out is actually a loan and you need to payback that loan within 15 years back into your RRSP.

Lifelong Learning Plan (Click Me!)

You can also use your RRSP to give yourself a student loan. You can borrow between $10,000 to $20,000 to go or return back to school. You will need to pay the loan back 5 years and 60 days after the first withdrawal, or the second year after the last year the student was enrolled in full-time studies

Spousal Plan (Click Me!)

The spousal plan allows a couple to contribute to each other’s RRSPs. For example I am a stay at home dad and not earning income or earning much less income than my wife, then Mrs. Prairie FIRE who earns a higher income is allowed to contribute to my RRSP. The benefits to this plan comes at retirement because it acts as a form of income splitting and lowers your tax burden as a couple when you start taking money out of your RRSP.

What is a TFSA

A Tax Free Savings Account (TFSA) is another type of account meant to encourage you to save. For what purpose? Well for pretty much anything you like – saving up for a down payment on a house/vehicle, vacation, and even retirement.

TFSA Super Powers

1. Flexible & Convenient (Click Me)

One of the great things about a TFSA is that you can use the money in it for whatever purpose you want. They are also super convenient, because you can take the money out of the account at any time without any tax implications.

2. Tax Free Growth & Tax Free Withdrawals (Click Me)

Whatever investment assets you decide to park in your TFSA tax shelter, any appreciation, interest or cash flow can be collected tax free. Just like an RRSP it has tax free growth super powers. But the TFSA one-ups RRSP in tax efficency because any money taken out of the TFSA is also tax free.

3. You Can Park Assets in It (Click Me)

Similar to an RRSP, you can hold a number of different kind of assets that grow in value tax free within an TFSA: Cash savings, Guaranteed Investment Certificats (GICs), Mutual Funds, Stocks, Bonds and my favourite- exchange traded Funds (ETFS).

TFSA Contribution Limits

Just like RRSPs, there are limits to how much you can contribute to your TFSA. This is not dependent on your income, but is set by the Government every year. Oh and the amount builds up over time. Below are the limits set by the GOC since 2009

  • 2009- 2013: $5,000/year
  • 2014: $5,500
  • 2015: One-time increase of $10,000
  • 2016-2018 $5,500
  • 2019: $6.000

The thing to note here is that the limit is cumulative. So if you turned 18 in 2009, then the total you can contribute during this time is $63,000. But if you turned 18 in 2019, you can only contribute $6,000.

Now You Know

So now you know the basics when it comes to RRSPs and TFSAs. I hope this post has helped take away some of the mystery on this topic. It can be intimidating at first to try and understand the subtle nuances between these two tax shelters. But it is not as hard as you might think and now that you know, you can take some next steps in knowing which account you want to use and start contributing ASAP.

To avoid knowing these things is to live in financial ignorance. Our financial futures depend on it. Keep learning, keep talking with friends and family about finances, create a clear financial plan for the future.

All the best my friend,

Mr. Prairie FIRE