There are so many options out there to help you make smart investments for your financial future. It can be confusing to understand the differences between each option and what the pros and cons are. But don’t worry – we’re here to help! Below is a rundown on knowing the differences between RRSPs, RESPs, and TFSAs. Understanding these pillar savings plans can help you make informed decisions on where to best invest your money for an enriched financial plan.
Registered Retirement Savings Plans (RRSPs)
The RRSP was created by the Canadian government to help individuals better save for their retirement.
So how does it work? Canadians can contribute up to 18% of their income earnings for a maximum of $26,500 per year. If you contribute less than the threshold in any given year, the allowable contribution carries forward year after year.
RRSPs have a particular tax advantage that makes your contributions to the account tax-deductible. You will receive a tax receipt based on the amount you have contributed each year. Also, any contributions made to an RRSP account will lower your taxable income for the year, meaning you will owe fewer taxes the more money you put into an RRSP.
PRO TIP: For the best use of your RRSP tax refund, invest it right back into your RRSP for exponential growth. Want more tax refund tips? Read our blog on The Best Ways to Spend Your Tax Refund.
While tax deductions are helpful while an investment is growing, you will be taxed once you withdraw. In most cases, however, you are in a lower tax bracket when you retire since you are no longer making an annual income. The lower tax bracket will mean that you will pay less tax on the withdrawal of your RRSP.
Another great advantage of the RRSP is the Home Buyer’s Plan, which allows individuals to withdraw up to $35,000 from their RRSP to invest in a new home without having to pay any penalty. The only stipulation is that the amount withdrawn must be re-invested back into the RRSP within 15 years.
Registered Education Savings Plans (RESPs)
An RESP is a savings account created to save for your child’s post-secondary education.
RESPs have a similar tax advantage as RRSPs that make the investment free from tax until it’s withdrawn for your child’s education.
Parents, other family and friends can contribute a lifetime total of $50,000 per child. The government also assists you with the Canadian Education Savings Grant (CESG). The CESG provides 20% of what you have invested, up to $500 per year to your RESP. Meaning if you’re allocating $2500 per year on an RESP, the government will provide $500 of free money annually towards your child’s future education.
If you’re looking to invest more than $2500 per year, many experts recommend putting the extra funds in a TFSA. This way, you take full advantage of the government grant and avoid taxation on your additional contributions when it’s time to withdraw.
Tax-Free Savings Accounts (TFSAs)
A TFSA is a personal savings account that allows you to save money for almost any purpose.
People 18 years and older can save up to $6,000 per year in a TFSA. If you contribute more than the allowable amount, you will be subject to a tax equal to 1% of the highest excess amount in a given month, for each month that the excess remains in your account.
TFSAs have a unique tax advantage that makes the income from the investment completely tax-exempt even once you have withdrawn the amount.
The biggest challenge with the TFSA is that it can be tempting to withdraw the money for other purposes before reaching your goal because there are no tax repercussions for withdrawal.
Knowing the difference between RRSPs, RESPs, and TFSAs is just the first step. If you’re still unsure what investment account is right for your goals? Don’t sweat it. Finally provides you with product recommendations best suited for each of your goals. Check us out here.
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