Where to put my money? RRSP? RESP? TSFA?
About the Author: Wilson Wong PC, are Chartered Accountants in Calgary providing tax and accounting services to small and medium sized businesses and high networth individuals.
I am presenting this article because a lot of people don't really understand the tax implication of each of RRSP, RESP, and TSFA contributions. If you truly understand the short term and long term tax implications for all these instruments then you can truly understand and make an informed decision on where to put your money if you had to choose one.
Therefore I am first explaining the tax implications in the most basic and short term first:
RRSP (registered retirement savings plans) contributions made by you into your account are deducted from your income in the tax year you made the contribution. Ok that's not entirely true, you can actually go all the way 60 days into the next year, that's besides the point.
RESP (registered education savings plans) contributions made by you do not do anything on your income tax return at all. Therefore, you are actually using after tax money to make the contribution.
TFSA (tax free savings account) contributions are just like RESP's, such that they do nothing on your income tax return. Again, you are using after tax money to make the contribution.
For all three types of instruments there are rules governing the maximum amount you may contribute into each one, they each have their own rules and own limits but this article isn't going to talk about what those rules are because that can be an article in itself. I'm only going to focus on where to park your money, and I mention the existance of these rules so that we're all on the same page with the fact that each instrument is governed by a limit and the limit is different for each one.
In the long run - please read this article on what happens to RRSP's http://www.wwongaccounting.com/knowledge/rrspissues.html - in general, you find that all income earned within the account through out time is not taxed so long as the money is still inside the account.
What about RESP's and TFSA's? The same rule applies, all the income that is earned within each account is not taxed so long as the money is still inside the account.
So what happens when you take the money out? Here lies drastic differences for all three instruments:
RRSP - all amounts are taxed as full income in the year of withdrawal.
RESP - as the withdrawal is likely for a child or beneficiary if this individual is not going to school with this money then generally speaking the same rules apply as in RRSP. For that matter, even if they are going to school, in my humble opinion the CRA simply provides the illusion that this money is withdrawn tax free but actually is being taxed but simply using up certain tax benefits available to students. Yeah I'm not a big fan of these as you can see.
TFSA - completely tax free withdrawals, but you should recall the above that after tax paid up income is being used to make these contributions.
Now we have a fair picture of what these 3 instruments do in the short term (when you contribute), during the lifetime of the account (medium term), and when you finally want to use the money (long term).
Given the above facts, it is always optimal to use this strategy:
1) Maximize RRSP's first among the 3 types
2) Maximize TFSA's second
3) Then use RESP's if there are children or grandchildren
Why are RESP's last? Because it yields no short term gain and double tax in the long term upon withdrawal. RESP's are a special program that in the medium term the government will make a matching contribution up to a limit which is essentially free money from the government since the idea is for the benefit of someone going to school. However, look at what happens on withdrawal, the beneficiary going to school will end up being taxed for both the government portion and the original portion that was contributed using after tax money. So that's essentially a double tax scenario.
Ok - it is still free money from the government and we can't turn it away. Just because it will end up being taxable money doesn't mean we turn away from this program altogether. From a total short-medium-long-term perspective however, you should seek the maximize the 3 instruments in the order I present above. If you have the money you invest in all 3 of course. That would be your ultimate goal is my opinion on this matter.
Should you have any further questions do not hesitate to email me or call me at the office.
-Wilson Wong, Chartered Accountant