With the RRSP deadline coming up quickly for this year, we thought it best to review the ins and out of registered accounts here in Canada, namely the RRSP and TFSA. Each have some similarities and differences when it comes to taxable events, liquidity, and allowances for withdrawals and deposits.

Given that the contribution deadline for 2022 is fast approaching, let’s take a look at the RRSP or, registered retirement savings plan, first.

The RRSP

The RRSP is an account that allows for contributions to be made against your gross income for tax-deferred growth.

So, let’s unpack that a bit. Contributions made against your gross income means that any contribution made into the account in the calendar year of contribution or the first 60 days of the following year can be applied against your gross income, lowering the effective tax you pay for that year.

As an example, Jim makes $200,000 in gross income in 2022. On February 1st of 2023, Jim makes his maximum contribution to his RRSP. The maximum contribution for the 2022 tax year is the lesser of 18% of your gross income, or a maximum of $29,210. Jim would qualify to contribute the 2022 maximum of $29,210 as it would be the lesser amount of 18% of his total gross income ($36,000).

Jim’s gross income then, is reduced from $200,000 down to $171,790, lowering the taxes payable for the 2022 year. An easy tax-savings calculator can be found here.

As an aside, you can contribute to your RRSP and not claim the deduction against your gross income and instead carry that contribution amount forward to a year in which you are earning a higher income and thus, saving more on tax. Usually however, people would rather make that contribution to a TFSA due to the higher liquidity and tax free nature of the account. We will elaborate on that later.

The contributions then grow on a tax-deferred basis based on the investments within the account. Tax-deferred meaning that although no taxes are applied to transactions in the account in the year in which they occur, any withdrawals from the account will have a withholding tax applied at the time of withdrawal.

The withholding tax schedule works as follows:

On the first $5,000 – 10% withholding tax applied

On $5,001 – $15,000 – 20% withholding tax applied

On $15,000+ – 30% withholding tax applied

The RRSP withdrawal is added to your gross income for the year, so if your marginal rate is higher than the tax rate applied to your withdrawal, you may owe further tax at tax time. For retirement planning, usually that means reserving any RRSP withdrawals for your retirement years as your gross income is typically lower in retirement than during any of your working years.

However, there are some withdrawals that can be made that avoid taxes. The first being the First Time Home Buyers Plan where those who are purchasing their first home are able to withdraw up to $35,000 from their RRSP tax-free to be put towards the purchase of a house. There are some conditions on HBP that can be found here. This is a one-time withdrawal that has to be re-paid back into the RRSP within 15 years. Keep in mind that when paying back the HBP withdrawal, those contributions cannot be used against your gross income as you would essentially be double-dipping on the tax benefits.

The second is the Lifelong Learning Plan in which $10,000 can be withdrawn from your RRSP in order to finance full-time training or education for you or your spouse. You can withdraw a total of $20,000 that has to be paid back over a span of 10 years. More information on the LLP can be found here. The same rule exists for re-payment of the LLP. It does not count again as a contribution against your gross income for the year. 

The TFSA

The TFSA or Tax-Free Savings account is a tax-free investment account where any gains, from income to dividends to capital gains are not taxed, either in the account or when later withdrawn from the account. Contributions can be made into the account beginning in the year in which the investor becomes 18. Unlike the RRSP, the contributions are not based on income, but rather an annual limit set by the Canadian government. Currently the lifetime contribution room for the TFSA has grown to $88,000 with the annual limits ranging from $5,000 to $10,000 in certain years.

The TFSA annual contribution limits are as follows: 

 

With the tax-free rules applied to the TFSA, it is much more flexible an account than the RRSP as several withdrawals and deposits can be made over the course of the year. However, if withdrawals are being made, you have to ensure that you are following the deposit rules associated with the TFSA.

For example, let’s assume an investor contributes the lifetime allowance of $88,000 on January 1st of 2023. The investor then makes an investment which doubles the capital in the account to $176,000, and they subsequently withdraw all the money to be used as a down payment on a house. They would now have to wait until the next calendar year to make a contribution back into the TFSA. This is because in the eyes of the CRA, the lifetime contribution was already made to the account and their contribution room now sits at $0.

In the following calendar year, the investor’s lifetime room will reset back to $88,000 plus whatever the government deems appropriate for that year. Since 2016, the contribution room has increased at 2.5% per year, rounded to the nearest $500.

In this case however, the only contribution the investor could make would be the $88,000 plus the presumed extra $6,500 for 2024. The investor would not be able to re-contribute the full amount, only the lifetime contribution limit.

In a situation like this, the investor would be smarter to withdraw the first $88,000 in 2023, use the First Time Home Buyers Plan to access another $35,000 from their RRSP, if possible, and leave the remaining $88,000 inside the TFSA, allowing for more growth and another contribution of the lifetime limit when the calendar turns over to the following year.

As you can see the TFSA is a much more flexible account with significantly less rules when it comes to withdrawals and deposits.

Which Account Should I Use For…..

The most important observation an investor can make when choosing between the RRSP or the TFSA is liquidity and potential access to the funds. If you’re saving for that first home purchase, the first $35,000 you save should, in my opinion, go into the RRSP if you have already ensured that you qualify for the Home Buyers Program. You can access that money tax-free if the contribution was made more than 90 days before the withdrawal request.

Beyond the initial $35,000, your home purchase savings should be allocated to the TFSA where you are free to contribute and withdrawal at your leisure assuming you are not going beyond the lifetime contribution limit.

For any major purchases outside that of your first home, the TFSA is the better option for all savings because of the previously mentioned liquidity and tax avoidance.

What Should I Buy in Each Account?

Many people duplicate their holdings across all their accounts and while efficient from an organization standpoint, you may be leaving some return on the table by doing so. The Canada and US have a tax treaty that encompasses RRSPs, RRIFs, LIRAs, etc but do not extend to the TFSA.

So, if you’re an investor that prefers a balanced portfolio in your equity sleeve that comprises both dividend-paying stocks and growth stocks, we believe that your allocation should look like this.

The RRSP:

All dividend-paying stocks (Canada and US) – The treaty between the US and Canada will allow for the income and dividends generated from US-investments to avoid tax at the time of distribution. However, the dividend income you receive from US-based companies will have a 15% withholding tax applied at the time of distribution in the TFSA account. Dividend stocks usually underperform a basket of growth stocks and believe it or not, you don’t want your RRSP ballooning to $2 million dollars come retirement because of minimum withdrawal amounts once you have converted to a RRIF. You would rather house that kind of growth in the more liquid TFSA.

All dividend-paying mutual funds and ETFs – Some ETFs are created to following dividend paying stocks both North and South of the border. Keep them in your RRSP.

In short, all non-Canadian income should be realized in the RRSP to take advantage of the existing tax treaties.

 

The TFSA:

Growth-based investments – There is no better way to take advantage of capital growth than by using the TFSA. Stocks that shoot up in value can be sold without consideration of having to pay capital gains back to the CRA. Be careful when aiming for growth however, as your TFSA contribution is finite. Meaning that a first time investor makes their initial contribution in 2023 for $6,500 and invests it into a stock you expect to soar, then sells it for a 50% loss, that $3,250 of contribution room is gone forever and the only way to recoup that room in the account is by essentially doubling the leftover capital.

Growth-based mutual funds or ETFs – Many mutual funds attempt to create index-beating returns by investing in high-multiple growth stocks located around the world. For the investor that lacks the time to do the proper research on international stocks, these funds and ETFs are perfect to create returns that may not be as correlated to the North American markets as their own stock picks in the account.

By holding dividend-paying stocks in your RRSP and growth-focused stocks in your TFSA, you are doing your part in creating tax-efficient returns for yourself. We will speak more on the tax-efficient portfolio in a later blog post.

See you next time!

This information has been prepared by James Hogan who is an Investment Advisor/Portfolio Manager for iA Private Wealth Inc. and does not necessarily reflect the opinion of iA Private Wealth. The information contained in this newsletter comes from sources we believe reliable, but we cannot guarantee its accuracy or reliability. The opinions expressed are based on an analysis and interpretation dating from the date of publication and are subject to change without notice. Furthermore, they do not constitute an offer or solicitation to buy or sell any of the securities mentioned. The information contained herein may not apply to all types of investors. The Investment Advisor/Portfolio Manager can open accounts only in the provinces in which they are registered.

iA Private Wealth Inc. is a member of the Canadian Investor Protection Fund and the Investment Industry Regulatory Organization of Canada. iA Private Wealth is a trademark and business name under which iA Private Wealth Inc. operates.