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?
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:
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:
- They have special tax sheltering powers
- You can purchase and park certain kinds of assets within these tax shelters
- 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.
RRSPs are great and all, but their powers are not limitless. They have two major weaknesses
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.
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
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,