To understand the RRSP tax deduction in Canada, first you must learn the difference between the many types of investment bank accounts.
Types of Investment Bank Accounts
Canadians can hold two different kinds of investment accounts from the tax perspective. These two accounts can hold a variety of investment vehicles. There are more restrictions with what can be held in registered investment accounts.
Registered Investments: TFSAs, RRSPs & more
Registered Investment bank accounts create some kind of tax-deferral or tax-sheltering situation. The most common are the Tax-Free Savings Account (TFSA) and the Registered Retirement Savings Plan (RRSP).
Other examples include RESP’s (Registered Education Savings Plans), RDSP’s (Registered Disability Savings Plans), and RRIF’s (Registered Retirement Income Funds – this is what your RRSP’s convert to when you retire.)
Non-Registered Investment Bank Accounts
Non-registered investment accounts hold no special status with regard to taxes. You pay tax on all investment income earned. This may include stock-trading accounts, mutual funds, financial products and other investments such as rental properties. TFSAs and RRSPs can use some of these types of investments. Make sure you know where your money is when talking to your banker – it’s your money.
RRSP Tax Deduction
RRSPs are the most well known type of registered-investment account. When you contribute money to your RRSP it immediately reduces your taxable income. Most people have taxes deducted directly from their pay by their employer. Contributions to the RRSP often create a bigger tax refund for these people. It’s important to note that not everyone is eligible to receive a tax refund. If you haven’t paid any tax, you can’t get a refund.
Contributions to your RRSP are made with pre-tax dollars. When you contribute to your RRSP, it reduces your taxable income. When you withdraw from your RRSP, the income is taxed. Contributions to your RRSP defer your taxes from today to when you retire and make withdrawals.
Your RRSP space increases by 18% of the employment income you earn to a maximum amount of $27,830 in 2021. Follow this blog using the Subscribe button at the bottom to receive next year’s updated rules.
Building your RRSP investments is an important part of your comprehensive retirement plan. Invest and grow your contributions to fund your retirement. Holding GIC’s (Guaranteed Investment Certificates), government bonds, or cash in registered accounts loses real spending power to inflation.
TFSA Tax Implications
TFSAs are a newer type of registered investment account. The contributions to these accounts are with post-tax dollars. You pay tax on your income before contributing to your TFSA. The magic of these accounts is that you never pay tax on what they earn. This is extremely powerful and makes TFSAs a very important part of your retirement strategy.
The contribution room that you get every year has changed several times. For 2022, your contribution room is $6,000. For further details, check the CRA site page about contribution limits.
Invest appropriately. You don’t want cash sitting in your TFSA. Cash is not leveraging the tax-free element of the TFSA. Contact us for more tax help in this area.
How Much Can I Contribute to TFSAs and RRSPs?
To find out how much you can contribute, you can look at your Notice of Assessment (NOA) from your prior tax year. It will show how much room you have available in both accounts.
If you are behind on your taxes, the RRSP information will not be accurate. Get caught up on your taxes to see the updated room you have.
Alternatively, if you have CRA My Account (which we highly recommend registering for), you can log in and see the contribution room you have on the front page toward the bottom.
What Investments Can I Buy in TFSAs and RRSPs?
There are restrictions with what you can buy within these programs. Most people hold financial products purchased through financial institutions. These would be things like mutual funds, ETF’s, Stocks, Bonds and more.
You can’t hold rental properties or shares of a private corporation you own in RRSPs or TFSAs. However, if you own a small amount of private shares earned by working for your employer, it may be possible to hold them in your TFSA. Stock option plans are often required to operate outside of TFSAs or RRSPs.
Day Trading Tax Advice
Funds held in a TFSA and traded regularly on the stock market are considered active business income and are fully taxable. It is best to do day trading in non-registered accounts. It allows you to take advantage of tax breaks from trading losses and keeps you onside with CRA.
Inflation in Today’s Economy
Inflation is at thirty-year highs. Make sure that your financial planner is growing your investments in a manner that suits your risk profile. Many financial products are currently losing real spending power to inflation.
Talk to a Tax Accountant First
We commonly see customers who have gone to their bank and received terrible advice. They have had their investments placed in the wrong kind of products. If you’re more than 15 years from retirement, you should be in more risk-tolerant investments. Retired people should be in more conservative and fixed-income investments.
For example, investing in Canadian Savings Bonds paying out a rate of 1.25% annually when inflation is running at 3% is losing you 1.75% of the buying power every year.
Working with a financial advisor who has your interest at heart is very, very important. They need to be thinking about your outcomes, not their compensation. Often, retail bank staff sell the most profitable products for the bank. They may have sales quotas imposed by their employer. Usually, they don’t have the best interest of the customer at heart. If you feel you’re not getting good advice, talk to a tax accountant.
How Should I Invest?
Everyone’s financial and life situation is different. It would be irresponsible to provide a sweeping comment about how everyone should behave.
However, TFSAs and RRSPs are an important part of your comprehensive retirement plan. You need to find professional financial advisors who have your best interests at heart. This isn’t always an easy task.
If you don’t have much to invest, just start. Financial institutions will consider you “Retail Client.” As you grow your assets, more opportunities become available to find better products and work with better planners.
Questions About Tax & Investments?
If you have questions about any of these principles, accounts or a situation specific to yourself, please reach out to our team!
KATA Accounting Solutions Professional Corporation does not sell financial products or advise on the purchase of specific financial instruments. We can refer people to financial planners we feel are trustworthy, but we will refer you to more than one and the choice is ultimately yours.
Contact KATA Today for all your accounting and tax needs