Whether you own a business, or a healthcare practice, or you are a working professional, you want to invest your hard-earned income wisely. A prudent investment will be one that allows you to meet your objectives like saving for retirement or your children’s higher education while ensuring you minimize your tax liabilities. The good news is that the Federal government understands your needs and has introduced various savings plans to help Canadians opt for either initial tax-deductible options or paying taxes upfront and reaping the rewards later.
The question is – do you choose just one plan or a medley of plans for maximum benefits? Let’s delve a little deeper into how each of these savings plans, namely RRSP, RESP, and TFSA, can help you reach your savings goal. With this knowledge, you will be in a better position to decide which savings plan or a combination of plans is best for you.
RRSP, TFSA, RESP, What Does it Mean?
What is an RRSP?
As the name suggests, a Registered Retirement Savings Plan (RRSP) is a plan registered with the Canada Revenue Agency (CRA) towards which you contribute for saving toward your retirement. You pay taxes on any contributions and gains made on investments when you withdraw this amount.
How much can you contribute towards an RRSP?
Generally speaking, the contribution limit has increased over the past few years. The RRSP contribution limit for 2022 is equal to 18% of your earned income from the previous year or $29,210, whichever is lower. In 2023, it will be 18 percent of your previous year’s earned income, or $30,780 – whichever is lower. The limit is reduced further if you have company-sponsored pension plan contributions.
What is a TFSA?
A Tax-Free Savings Account (TFSA) refers to a type of investment made by Canadians over 18 years of age after paying initial tax to the CRA. Under this plan, your amount grows tax-free. So, you do not pay for any income on earnings when you withdraw it.
How much can you contribute towards a TFSA?
- In 2022, the annual limit is $6,000. The limit carries over every year. That means, if you don’t contribute the maximum amount, you can make it up in later years. The limit for 2023 has been announced at $6,500.
- If you take money out, you can also hold on to that contribution room and make it up later (just not in the same year).You can have more than one TFSA per year but cannot contribute more than the TFSA contribution room for the year.
- Also, your TFSA contribution room for the current and future years is not affected by income earned.
- You can replace or re-contribute all or a part of your withdrawals into your TFSA in the same year if you have an available TFSA contribution limit. Withdrawals made from your TFSA during the year will not be added to your TFSA contribution room until the beginning of the following year.
According to the CRA, a TFSA contribution room is a total amount of:
- TFSA dollar limit – This limit changes every few years, is indexed to inflation, and rounded to the nearest $500. For the years 2019 to 2022, this limit is $6,000.
- Any unused TFSA contributions from previous years.
- Withdrawals made during the previous years.
What is an RESP?
A Registered Education Savings Plan (RESP) is meant for saving towards your child/children’s future education. You can start this plan for your children, nephews, nieces, grandchildren, or family friends as long as the beneficiary is a Canadian resident and has a Social Insurance Number (SIN).
- The amount you invest is not tax deductible.
- Canada Education Savings Grant (CESG) plan matches 20 percent of your savings per student till age 18, up to $2,500 each year to a maximum amount of $7,200 over the life of the plan.
In addition to the CESG provided by the federal government, Quebec residents have been given an incentive called the Quebec Education Savings Incentive (QESI) to start saving early for post-secondary education.
- This is a refundable tax-free measure for families having a registered RESP opened with a provider that offers QESI.
- To avail of this credit, the trustee appointed by the RESP provider should apply for it with Revenue Quebec.
- The tax credit is paid directly into the registered RESP opened with the QESI provider.
How much can you contribute towards RESP?
There is no limit to the number of investments under an individual’s name. Also, there is no annual limit on how much you can put away. However, the basic 20% Canada Education Savings Grant (CESG) and 10% Quebec Education Savings Incentive (QESI) are only applicable on the first $2,500 of annual personal contributions to an RESP. Any amount over $2,500 is not eligible for these grants.
In some instances, you may find yourself in the position of being able to claim grants from previous years that you did not get. In this instance, an extra $2,500 (so a total of $5,000 in a given year) may be eligible for grant, but you will want to make sure before contributing in excess of $2,500 in a given year. However, there is a lifetime contribution limit of $50,000 per beneficiary. Your RESP can remain open for up to 35 years.
RRSP vs TFSA vs RESP– Where Should You Invest First?
Whether you are a new business owner or are well established in your field, you want to benefit from tax reductions as permissible by the Canadian government. You can attain this by maximizing your contributions towards an RRSP first, followed by RESP contributions towards children’s education (if any), and lastly by investing in a TFSA. Let’s explain this better with an example.
Let’s assume that you have $30,000 to invest. You should ideally utilize the full amount of $30,000 on the RRSP. Out of this amount, you may get a return of $15,000 (assuming a combined marginal tax rate of 50%). Let’s assume you have two minor children. You can decide to invest $5,000 in an RESP and get $1,500 in grants (20% from federal + 10% from Quebec). The remaining $10,000 can be invested in a TFSA.
Did you follow me there? You took $30,000 and turned it into $46,500 of money working for you!
Transferring funds between RRSP and TFSA or RRSP and RESP
Between RRSP and TFSA
Direct transfers cannot be made between an RRSP and a TFSA.
To use funds from an RRSP and invest in a TFSA, you need to:
- Withdraw the funds from the RRSP
- Pay any applicable withholding tax and additional taxes, at tax time
- Have the available contribution room in your TFSA
TFSA to RRSP transfers cannot be done directly. You need to:
- Sell for cash in one and repurchase them in another.
- Have the available contribution room in your RRSP and contribute the funds towards it.
Note: TFSA withdrawals from your contribution room are added back the following year. However, when withdrawing from an RRSP, your contribution room is lost for the amount withdrawn, subject to some exceptions.
Between RRSP and RESP
Direct transfer of funds cannot be made between an RRSP and an RESP.
To move funds from your RRSP to an RESP, you should:
- Withdraw the funds from the RRSP. You will lose the re-contribution space from your RRSP once you withdraw from it.
- Pay any applicable withholding tax and additional taxes, at tax time.
RESP to RRSP transfers
If your student beneficiary decides not to pursue higher education, one option is to move the funds to an RRSP.
- To enable transfer from an RESP, the beneficiary should be at least 21 years old and not pursuing higher education.
- The financial institution will return any grants given by the Canadian government.
Choosing the Right Savings Plan?
RRSPs, TFSAs and RESPs are all great ways to invest your money. Each has its own set of benefits, whether it’s saving taxes, investing in your child’s future, funding short- or long-term projects or making your investments grow tax-free. Knowing how to invest in the right place at the right time will allow you to maximize your tax savings while increasing your gains and achieving your goals sooner. Rely on investment and tax planning experts to guide you on how to create the right portfolio with RRSP, TFSA and RESP investments for the best returns.
At The St-Georges Group, maximizing the profitability of your investments while taking advantage of tax savings is one of the many wealth management strategies we offer. Do not hesitate to contact our team of strategic wealth advisors for more information on our wealth management services.
See the following table for a useful summary of the key differences between RRSPs, TFSAs and RESPs. You can download a PDF version of this comparison table here.
About the Author
Darren St-Georges is a senior wealth management advisor at Assante with over 15 years of experience. Assisted by a team of experts, he has helped many clients, such as dentists, health professionals and business owners, simplify complex financial issues and achieve their financial goals. Darren offers a personalized and integrated approach to wealth management. His mission is to use his experience and skills to bring financial peace of mind to his clients. Contact Darren for expert wealth management advice.
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