You’re finally ready to do it: to put money away or become more intentional with your savings plan! You figured out the amount and you’re ready to dive in and watch your money work for you. And with all the excitement and hopefulness of creating a solid financial future, you stop – paralyzed and confused about where to put your money. Soon those feelings of expectation and the dreams of buying that home, taking that trip, or saving for retirement are quickly swept away by the daunting task of figuring out which savings account is right for you. There are too many to choose from, and understanding the ins and outs of each option is overwhelming. So, instead of trying to dig your way through it, you toss up your hands and give up, because you think not saving and staying on your current financial path is so much easier.
Let’s take out all the noise and simplify your savings decision. Deciding which accounts to use for your savings goals should never be overwhelming. Use this simple guide to select the best choice for you. Remember, no two savings plans are alike, and it is important that you place your money in accounts that align with your financial goals and desires.
A savings account is typically the most common account used to put money away for financial goals. A savings account pays interest on the money you deposit into the account. Your money is guaranteed to grow based on the interest rate, and there is no risk of losing money due to market changes and fluctuations. This makes a savings account very appealing, as your money is safe and secure. Another key advantage is that your money is easily accessible and can be withdrawn immediately if you need it.
Now before you get excited and select this option for your savings needs, you should also be aware of the downsides. Savings accounts have extremely low interest rates. A regular savings account won’t cut it if you’re hoping your money will actually grow – unless you don’t mind waiting a very long time for those results. Also, savings accounts are taxable accounts. You must pay income tax on the interest earned in your account during the year (depending on the amount). Your financial institution will send you a T5 tax slip which must be reported on your personal tax return.
Tax-Free Savings Account (TFSA)
A TFSA is a registered account that allows you to save and grow your money tax-free. No, that’s not a joke. There are no taxes on the growth of your money and zero tax or penalties when you withdraw. One of the greatest misconceptions about the TFSA is caused by its name – ‘Savings Account’. Although you can open a general TFSA savings account, there are many more options available to you. For instance, you can open a TFSA investment account and hold investments like GICs, stocks, bonds, mutual funds, ETFs, etc. within your TFSA. This allows you to maximize the growth of your money without paying taxes when you are ready to use it.
Each year the CRA releases the TFSA contribution limit for that year. The limit for 2021 is $6,000. However, this may not be your contribution limit, as all prior year unused contribution room is accumulated. For instance, if you have never opened a TFSA and were over the age of 18 since its introduction in 2009, then your cumulative contribution room for 2021 would be $75,500. To obtain your personal contribution room review your latest Notice of Assessment or sign in to your CRA ‘My Account’ online.
A TFSA is great for saving for your emergency fund or short-term goals like vacations, buying a new car or a home. It can also be used to save for your retirement as there are no tax penalties at the time of withdrawal. This is an advantageous option when you have a significant amount of unused TFSA contribution room or if you have exhausted your RRSP contribution room. However, this comes with one big warning point: If you use a TFSA for retirement purposes, you must exercise discipline and not withdraw the money for short term needs. Due to the ease in which you can access your funds, it creates a risk that funds will be used for other purposes.
Registered Retirement Savings Plan (RRSP)
A RRSP is a registered account that provides tax-deferred advantages when saving for your retirement. What does that mean? Contributions into a RRSP are not taxed in the year you make the contribution, and they reduce your taxable income and can result in a refund when filing your tax return. Instead of paying tax at the time of contribution the tax is “deferred” until you are ready to retire and begin to withdraw from your account. At this time, you are taxed on any amount that you withdraw.
There are two limits you must understand when it comes to the RRSP – deduction limit and contribution limit. The deduction limit is how much of your RRSP contribution you can deduct on your tax return, which will result in reducing your taxable income for the year. The deduction limit is either 1) 18% of your prior year earned income or 2) a maximum amount set by the CRA each year, whichever is smaller. The maximum amount for 2020 is $27,230 and for 2021 is $27,830.
The contribution limit is the maximum amount an individual taxpayer can contribute into their RRSP for the year. This is unique to each person as it’s based on the current year’s deduction limit plus any unused contribution room from prior years. To obtain your personal contribution, room review your latest Notice of Assessment or sign in to your CRA ‘My Account’ online.
One important thing to note is that if you withdraw funds from a RRSP prior to retirement, you will have to pay tax plus a penalty. So, be sure you are only contributing funds that are designated for retirement and are not required for short term needs.
Non-Registered Investment Accounts
Non-registered accounts do not have the same tax advantages when contributing into the account as do the RRSP and TFSA. You can, however, hold any type of investment within these accounts but the growth on your funds is not tax-exempt. There is no contribution or withdraw limit on non-registered accounts which can make them advantageous. But when you withdraw money, it is subject to tax and must be reported on your tax return. Non-registered accounts are a great option once you have exhausted your TFSA & RRSP contribution limits. Your money also has the potential to grow faster than a regular savings account, dependent on what investments you choose.
Before selecting a savings account, you must be clear on your financial goals and objectives. This includes what you will be using the money for and the time horizon in which you will need it. Also, consider if you want your money to grow or if you prefer safety and security as opposed to growth. The answers to these questions will help to decide which account is best to meet your goals. You can have different accounts depending on your various goals. Remember, no savings plan is the same, and building your financial dreams is just as unique as you are.
Vanessa Bowen is a Chartered Professional Accountant (CPA) and Master Neuro-Linguistic Programming Practitioner (NLP) and the Founder of Mint Worthy, a personal finance coaching platform that helps women shift their relationship with money and take control of their finances.
Vanessa Bowen is a paid spokesperson of Sonnet Insurance.