In my last blog post I discussed a number of issues related to arriving at retirement without the proper savings to support your lifestyle. In this second part I want to highlight some investment vehicles available to build wealth. Our focus here relates to investments in equity markets and fixed income securities, which is my area of expertise.
As always, special attention needs to be given to every individual situation. I want to divide the focus into two groups: High-income and low-income earners at retirement. The investment vehicles used today for these two groups are going to have quite different outcomes when it comes to taxation and maximizing the benefits of government programs (CPP, OAS, GIS) in retirement.
In Canada the investment vehicles most commonly used by teachers are:
- Registered Retirement Savings Plans (RRSPs)
- Tax Free Savings Accounts (TFSAs), and
- Non-Registered accounts (OPEN).
These accounts have different rules set by the CRA, and it is important to understand where to invest at different times in your life.
Registered Retirement Savings Plan
An RRSP is retirement savings vehicle. Income generated within the plan is tax-sheltered until you take it out, and you get a tax benefit today for any contributions into the plan. When you redeem assets from the RRSPs (now or in retirement) you will have to include the redemption as income for that given year. If you have an income that is relatively high and you expect your retirement income to be lower in retirement, then you certainly want to invest in an RRSP. If your spouse is earning a higher income than you, he or she may set up a spousal RRSP where you use your contribution room and your spouse gets the tax break today (income splitting). The maximum RRSP contribution per year is 18% of your gross income or $27,230, whichever is lower for the year.
Since RRSPs result in a greater tax benefit for those in a higher tax brackets, I recommend that teachers contribute to TFSAs during the early years of their tenure and use the RRSP deductions later on when their income is higher.
Tax Free Savings Account
A TFSA works differently than the RRSP in that you only use after-tax dollars to invest in it. Meaning, you do not get a tax break when you deposit funds in it. However, the growth within the TFSA is tax free. TFSAs are great investment vehicles for folks that expect their retirement income to be higher than their current income. It also allows you to have greater access to funds today since there are no tax consequences when withdrawing from these accounts. If you were born before 1991 and have never invested in a TFSA then you would have $69,500 of TFSA contribution room.
Since TFSA withdrawals are not taxed and the contribution limit is reloaded in the following year, TFSAs can be more beneficial for those who intend to withdraw from them before retirement.
Non-Registered or Open Account
Non-Registered or Open Accounts allow you to invest in funds with little to no contribution restrictions; however, depending on the performance of the assets, you may have to pay taxes on the interest earned, income earned, or capital gains. Open accounts are often used when clients run out of TFSA/RRSP contribution room or when there are family assets that need to be held jointly within family members.
Which one is best for me?
As mentioned earlier, it is nearly impossible to make a recommendation without accurately assessing your specific situation. You don’t want to be in a position where you cannot access the funds you have invested for an emergency or purchase of a home or any other big-ticket item. You also do not want to take unnecessary risk without accurately assessing your investment timeline and goals. With a proper assessment, we can determine how much time you have available and your appetite for risk.
In the long run, while both RRSPs and TFSAs both have great benefits, their different characteristics need to be considered for one’s wise retirement planning.
If you have any questions or would like to discuss your specific situation, please feel free to reach out and we can chat.
Post written by: Dan Fernandez
Dan is a Wealth Advisor with DMF Private Wealth, who provides independent financial advice.
Dan is happy to answer any questions you may have about your financial picture. He can be reached at 905-512-5629 or by email at email@example.com.