Over the next month, you’ll likely see a lot of ads and articles reminding you to invest in an RRSP. This is because the deadline for investing in a new RRSP and qualifying for a rebate on your 2016 tax return is March 1st, 2017.
But RRSPs aren’t the only investment option at your disposal. And the advisors telling you that you’ll get a refund just by investing aren’t telling you the whole story. Depending on your stage of life and financial situation, you may be better off investing in TFSAs or RESPs. Here are some tips to help you figure out your best investment options.
RRSPs, RESPs, TFSAs: What the diff?
First, a quick primer on the three options.
Registered Retirement Savings Plans are an investment program created by the federal government to encourage individuals to save for their retirement. The investment options include GICs, bonds, shares, and mutual funds. Whatever amount you spend on your RRSP – up to your personal contribution limit – is deducted from your total income for that year. And the investment will also grow tax-free, meaning the government won’t charge you tax as you contribute to an RRSP.
If you’re a salaried employee, you’ll be refunded the federal income tax that was deducted from that amount. Or if you’re self-employed, the amount of tax you owe will be reduced. As mentioned before, you will get a tax-deduction for the year you purchase your RRSP.
Tax-Free Savings Accounts are similar to RRSPs, with the same suite of investing options, but with two major differences: there’s no tax deduction (unless under certain special circumstances) and funds are not taxed when they are withdrawn.
Register Education Savings Plans are another federal program that encourages parents to set up investment accounts with the idea that this money can be used in the future for their child’s post-secondary education. These accounts are also open to grandparents, aunt and uncles, and anyone else interest in investing in a child’s education. As an added incentive, the government provides a 20 per cent Canada Education Savings Grant on every dollar contributed to an RESP, up to $500 a year, and $7,200 over a child’s lifetime. As with RRSPs and TFSAs, investments grow tax-free. But when funds are withdrawn, they are considered taxable income for the child, though this will most likely be in the lowest tax bracket.
The cons of an RRSP
There’s a downside to the RRSP that most people overlook: When retirement finally rolls around, any money you withdraw from your RRSP will be considered taxable income for that year.
Depending on your financial situation, you could be trading in a rather small tax return now for a big tax bill down the road. Here’s how. Say you’re making $30,000 a year. That would put you in the lowest tax bracket at 15 per cent. Withdrawing a $5,000 RRSP contribution would land you $750 in payable taxes.
But if you make it into the six-figure arena by the time you retire, you’ll be in the highest tax bracket (currently 33 per cent). At those rates, you’ll have to pay $1,650 in tax to withdraw that $5,000.
Admittedly this is a simplistic analysis, but the point is that if you’re in a field where you can reasonably expect a steady upward trajectory in your annual income – lawyer, investment banking, etc. – a TFSA may be a better investment for the long-term.
The pros of an RRSP
There are some perks to investing in an RRSP in the form of exclusive loan programs.
If you are planning on buying your first home in the next few years, you’re able to withdraw up to $25,000 from your RRSPs through the Home Buyers’ Plan (HBP). And if you invest your tax return in something secure such as a GIC or bonds, this can be a helpful way to save up for your down payment. But keep in mind once again that this withdrawal is seen as somewhat of a loan, and you will be required to pay that money back into your RRSP account in installments over 15 years.
There’s also a similar RRSP program called the Lifelong Learning Plan (LLP), that allows you to withdraw up to $10,000 a year – to a total maximum of $20,000 – from your RRSP to pay for full-time post-secondary education for you or your spouse/common-law partner.
Different lifestyles = different types of investments
If you’re just starting out in your career and aren’t depending on a tax return to help fund something else (say, a holiday or paying down some other debt), you might be better off investing in a TFSA.
If you’re already a high earner and aren’t relying on a tax return to fund your lifestyle, max out your TFSA first to minimize your tax burden down the road.
If you’re saving for a down payment on your first home, consider reinvesting your RRSP tax return in a stable but easily liquidated option, and withdrawing funds from the Home Buyers’ Plan when necessary.
Finally, if you have young children and like the idea of the government giving you a 20 per cent top-up on your investments, open an RESP account.
At the end of the day, everyone’s situation is a little bit different. You may even find it best to have a mixed (dare we say, diverse) portfolio of investments.
So before you go jumping into an RRSP program, it’s best to completely assess your current situation, have an idea of what your short-term financial goals are, and consider where you might stand financially in the future. Otherwise, it may be best to weigh other investment options.