Being tax smart with government savings accounts is an important aspect of savings growth. When it comes to accumulating savings, step one is always to spend less than you earn. When it comes to growing our savings, many of us jump next into specific investment products such as stocks, bonds and mutual funds. A word of caution however, as we must remind ourselves that what really matters is net investment return, i.e. savings plus return earned on savings less taxes less fees.
We therefore need to consider the impact taxes will have on our invested savings (we’ll save a discussion on fees for another day). This should be done ahead of specific investment selection or at the very least in concert with.
There are a handful of government savings accounts with tax advantages available to Canadians. Over a person’s lifetime, the difference between poor and efficient use of these government savings accounts can quite honestly impact net investment return by tens of thousands of dollars. Consider the following as you let that sink in:
- Invest savings in tax sheltered accounts first. This means maxing out your RRSP, TFSA, voluntary contributions to a registered workplace pension, RESP (those with children) and even the RDSP (dependent family member with a disability) before even a penny is invested in a taxable (non-registered) investment account. Spouses can contribute directly to each other’s TFSA (say in the case of a single income family). The same cannot be said for RRSPs however.
- Max out higher earner’s RRSP first. The statistics are clear, the vast majority of Canadians are not making full use of their RRSP contribution room. For spouses and common law couples not able to max out both RRSP accounts (which as noted is most of us), max out the higher earner’s RRSP first. This is because the associated tax deduction will be of more benefit to the higher earner. Along with this strategy, make use of spousal RRSP contributions with the long-term aim of equal income levels for each spouse in retirement.
- TFSA before RRSP. For those of us earning low to modest incomes and unable to max out both accounts, starting with the TFSA is usually the way to go. As a rule of thumb, use annual income of $45,000 as the tipping point in the TFSA vs. RRSP debate. The graduated Federal tax brackets jump up at ~$45,000 and thus the tax savings from the deduction resulting from an RRSP contribution is greater on income above $45,000.
- Defer RRSP deduction. Keep in mind that the tax deduction arising on RRSP contributions is discretionary. Someone anticipating an imminent jump in tax brackets can take advantage of this by deferring an RRSP deduction for greater tax relief in future. A broader takeaway here is the importance of paying attention to your marginal (top) tax bracket. Consider this simple illustration with reference to point 3: someone earning $50,000 with $10,000 to invest might consider putting $5,000 in their RRSP (to bring their taxable income down to the $45,000 tax bracket) and the balance in their TFSA.
- RESP: a guaranteed 20% rate of return. An annual contribution of $2,500 to a loved one’s RESP will trigger the maximum associated government contribution of $500. That’s a guaranteed 20% after-tax rate of return which is unheard of in today’s markets! For those of us inclined to help with a loved one’s post-secondary education bill, an RESP contribution is likely to provide the biggest initial “bang for their buck” in comparison to other tax advantaged account contributions. If retirement savings is less of an issue, for example someone with a solid workplace pension, one might consider allotting their first savings dollars here.
Canadians are currently in the midst of personal tax season and as professional tax advisers we’re busy at parker simone LLP preparing 2015 personal tax returns. That said, we know real value is created with the tax planning that accompanies and usually precedes tax preparation. Effective tax planning is an on-going exercise requiring consistent engagement between trusted knowledgeable adviser and proactive client working together as a partnership. At parker simone we therefore devise and implement tax planning strategies for our clients – like Government Savings Accounts above and many others – not just in March and April but rather ongoing through-out the year.
Pat, CPA, CA, is a senior manager with parker simone LLP and a ten year veteran of the public accounting space. He is a self-described student of all things business, accounting, taxation, personal finance and current events (thank you Steve Paikin and John Moore). Pat’s interest in sports and local organized runs was the driving force behind his existing stance as a fitness and wellness enthusiast at-large. Pat is active in community based volunteer work focused on financial literacy and societal integration of new immigrants.
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