Sunday, 22 February 2015

Financial Basics 3 - How Different Savings Accounts Work

This post is about the different types of savings accounts you can use in Canada.  

Article was edited March 2017, to update TFSA and RRSP limit amounts.

There are 3 levels of hierarchy to savings accounts and investments.  The three levels are:
  • Bank or Investment company
  • Type of account (TFSA, RRSP, RESP, Taxable)
  • Type of investment

The first, or highest, level is the bank, broker or investment company where you want to have your accounts.  I will discuss more on this in a later post, but essentially I recommend a self-directed account at a single institution.  At that company you can hold different types of accounts, one for your RRSP and a different one for TFSA etc.  You are allowed to have the same type of account at different banks but there is no reason to do that.  Within each account, you can hold many different types of investments such as bonds, stocks, ETF (exchange traded funds), mutual funds and fixed income products like GICs (guaranteed investment certificates).  More on this too, in a later post.

This post is about the second level in that hierarchy, the type of account.

The different accounts available to you have different objectives.  A TFSA is for short and long term savings.  An RRSP is for retirement savings whereas an RESP is for saving for your children's post-secondary education.  The real fundamental differences between these accounts is how they are taxed.  The TFSA, RRSP and RESP have some tax advantage over the ordinary Taxable account, which is why they are sometimes known as tax-advantaged. This focus on taxes and tax differences is why I posted the Income Tax post prior to this one.

Really, Really Basic Stuff

TFSA (Tax Free Savings Account)
  • Growth inside the account is not taxable and withdrawals are not taxed.
RRSP (Registered Retirement Savings Plan)
  • Contributions are tax deductible.  Growth is not taxed (until withdrawn).  All withdrawals are taxable.
Taxable (regular inestment or savings account)
  • Interest and dividends taxable at the appropriate rate in the year they are received.  Capital gains are taxable only when investment is sold (gain realized).
RESP (Registered Education Savings Plan)
  • Growth in the account is not taxed (until withdrawn). There are government matching grants (free money). Withdrawal of original money put in is not taxed. Growth and grant money is taxed in the name of the student (likely at a low tax rate).

The Basics (enough to get you started)

  • Begin contributions when you turn 18. 
  • Contribution limit of $5,500 per year (in 2017).
  • Contributions are not deductible from taxes.
  • Interest, dividends and gains in the account are NOT taxed.
  • Withdrawals are NOT taxed. 
  • No limit on withdrawals.
  • No upper age limit on contributions or withdrawals.
  • No minimum age to begin contributions (but you must have income)
  • Contribution limit is the lesser of 18% of previous year income or $26,010 (in 2017).
  • The contribution limit is reduced by what is known as the "Pension Amount", which is effectively contributions by an employer to your DC (Defined Contribution) or DB (Defined Benefit) pension plan. 
  • Contributions are deductible from taxes.
  • Contributions do not have to be deducted from taxes in the current year and can be carried over and deducted in subsequent years.
  • Contributions made in the first 60 days of the year can be deducted on the previous years tax return (The RRSP deadline!)
  • Interest, dividends and gains in the account are NOT taxed, but
  • Withdrawals are taxable. 
  • No limit on withdrawals
  • After age 71, no more contributions allowed and must be converted to a RRIF.  
RRIF (Registered Retirement Income Fund)
  • No contributions.
  • Minimum withdrawals are required, which is a percentage of the account that increases with age. 
  • Withdrawals are taxable. 
  • Unlike TFSA and RRSP accounts, it does not receive any favourable tax treatment.
  • No restrictions on withdrawals, contributions or type of investments it can hold.
  • Contributions are not tax deductible.  
  • Withdrawals are not taxable (if it's already cash)
  • Selling an investment will either trigger a capital gain or loss.  Capital gains are taxable when the investment is sold.  
  • Investments may create interest income and dividend income which are taxable in the year received.  See the Income Tax post for more details on how these are taxed.  
  • Used to specifically save to fund post-secondary education for your children.  
  • You can contribute up to $50,000 lifetime per child.
  • Government grant of 20% of your contributions up to $500 per year or $7200 lifetime.  So you should contribute $2500 per child per year for 14 and a bit years to get the maximum grant.
  • Additional grant is available for lower income families.
  • Contributions are not tax deductible.
  • You can withdraw funds once the oldest child has started post secondary education.
  • Withdrawal of the original contribution (the principal) is not taxed,
  • Withdrawal of grant amounts and growth on investments is taxed in the name of the child that the withdrawal is made for.  Usually the child has very low income when attending school so can recieve much of this tax free,  The withdrawals are physically paid to the account holder (the parent).

More Excruciating Details

I have listed some more details below that I consider to be very useful to understand how these accounts work.  There are very good references on these accounts in Wikipedia and at

  • Program started in 2009.
  • Contribution limit for 2009 to 2012 was $5000, for 2013 to 2014 it was $5500, for 2015 it was $10,000, for 2016 and 2017 it is back to $5,500. The contribution limit is indexed to CPI (consumer price index, or inflation) and rounded to the nearest $500.
  • If you do not use the contribution limit in a particular year, that amount can be carried over and contributed in later years.  
  • If you contribute more than your limit, then there are penalties. 
  • If you withdraw funds, then they can be re-contributed back in to the TFSA, but not until the next calendar year (January 1st of the next year). 
  • A TFSA passed to your beneficiary (on your death), if it is your spouse is tax free and can become part of the spouse's TFSA. 
  • A TFSA passed to your heirs (on your death) is tax free, but comes to them as cash and does not create any additional room in their TFSAs. 
  • Wikipedia TFSA
  • TFSA
  • Program started in 1957.
  • Contribution limit for 2016 was $25,370, in 2017 it is $26,010.  The contribution limit is index to CPI (consumer price index, or inflation) and is rounded to the nearest $10. 
  • Your contribution limit will be on your Notice of Assessment, which you receive each year after filing your income tax.  
  • If you do not use the contribution limit in a particular year, that amount that you can contribute can be carried over and contributed in later years.  
  • If you contribute more than your limit, then there are penalties. 
  • Before 2005 there were limits on the portion of the RRSP that could be foreign (non-Canadian).
  • If you withdraw funds, then they can not be re-contributed back in to the RRSP.
  • The RRSP HBP (Home Buyers Plan) is actually a way to use the RRSP funds and re-contribute them later.
  • An RRSP passed to your beneficiary (on your death), if it is your spouse, is tax free and can be part of the spouse's RRSP. 
  • An RRSP passed to your heirs (on your death) is withdrawn and taxed in the name of the estate and the proceeds passed as cash.   
  • Wikipedia RRSP
  • RRSP
  • If you pass cash or investments from your taxable account to your spouse or heirs (on your death), all of the investments are deemed to be sold and any income tax payable on capital gains and interest and dividends received prior to death is payable by the estate.  
  • A defined contribution pension plan (DCPP) is much like your RRSP.  Contributions to it by you or your employer reduces the amount (see Pension Amount above) you can contribute to your RRSP.  When you leave the employer by retiring or resigning, the DCPP will be paid to you, but must be put into a LIRA (Locked in Retirement Account) which then behaves much like an RRSP.
  • Contributions by you and employer. 
  • Limited by same limits as RRSPs.
  • Your and your employer's contributions are not taxed.
  • No withdrawals (except transfer to LIRA).
  • Investment funds are usually a select few chosen by your employer or the administrators of the plan. 
  • Is only created when transferring a DCPP from an employer you have left.  
  • No contributions.
  • No withdrawals.
  • To withdraw, the LIRA must be converted to a LIF. 
  • Wikipedia LIRA
  • LIRA
LIF (Locked in Income Fund)
  • Same rules as LIRA, except
  • There is both a Minimum and Maximum withdrawal that can be made each year.  It is a percentage of the account balance and increases with age. 
  • Withdrawals are taxable. 

My RESP for my children was setup via the bank advisors, so I am not familiar with some of the nuances of having a self-directed RESP.
  • You will need SIN numbers for the child(ren) before you set it up.  
  • Withdrawal of funds requires a visit to the bank to provide proof of enrolment in a post secondary institution.
  • When you withdraw funds the bank advisor will not be able to tell you how much of the withdrawal will be taxable.  But typically the growth and grant is withdrawn first and principal last.
  • Wikipedia RESP
  • RESP
  • BMO Investorline self-directed RESP page.

Types of Investments

I am not an authority on limitations on what types of investments you can hold in each of the accounts discussed above.  In a later post I will be proposing that your investments be wholly ETFs and a very select few of these.

You can hold the following in the above accounts
  • Stocks
  • Bonds
  • ETFs
  • GICs
  • Mutual Funds

Disclaimer:  These posts are not fully comprehensive financial advice.  You should seek your own qualified investment, tax and legal advice.

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