Ashleay: Welcome to iA Financial Group’s “In Your Interest!” podcast. My name is Ashleay, and this week we’re talking alphabets: RRSPs, TFSAs, FHSAs; a subject that may seem boring, but let’s face it, Sébastien, it’s a brilliant and profitable thing to talk about, right?
Sébastien: Indeed! And hello Ashleay, it’s always good to be here with you. I was talking with a few of my financial advisor friends recently and they were very excited about 2024 because we have an extra day to save. That was a joke—you know how they’re kind of funny. Anyways, it’s important to have a plan this year, as always. You want to be able to benefit fully from all these options that are on the table. So, yeah let’s talk about it.
Ashleay: All right. In a few words, Sébastien, what is a TFSA? How does it work? Is it airport security?
Sébastien: Yeah, pretty close! It’s a Tax-free Savings Account. So you were almost there. In a few words, I would say “TFSA rhymes with the flexibility.”
Ashleay: Okay. And is the TFSA for everyone?
Sébastien: Well, it’s recommended for everyone. For example, everyone should have a contingency fund inside the TFSA. This is the best tool for that because you have access to the liquidity there. But the priority level of a TFSA versus an RESP, RRSP or any of these options depends on everyone’s particular situation. We can briefly mention a few possible use cases. Let’s say you have an imminent purchase or you want to build a contingency fund. Well, the tax-free withdrawals that you get and the contribution room that is restored in the year following a withdrawal are interesting features. Additional income options at retirement: you can use the TFSA at the start of retirement to defer the Quebec pension plan and the old-age security pensions, thereby enhancing them, or you can withdraw from your RRSP in the years when your income is lower and your TFSA when your income is higher, meaning at a higher tax rate. So, it’s more advantageous to contribute to an RRSP when your tax rate is higher at the time of contribution and lower at the time of withdrawal, whereas a TFSA is more advantageous when your tax rate is lower at the time of contribution and higher at the time of withdrawal. It’s all about tax theory here, which is a complicated concept. But again, do your research and work with a financial advisor, who will guide you through all these tools as you prepare for retirement.
Ashleay: Great. And how do you calculate the maximum amount that you can invest in your TFSA?
Sébastien: The contribution room of a person who turned 18 after 2009 starts accumulating as of the year in which that person reached the age of majority. So, for example, a person who has never had a TFSA and who was at least 18 in 2009 would have a cumulative contribution room of $95,000 in 2024. So ample room for their needs.
Ashleay: Fantastic. And what type of investments options are there?
Sébastien: In layman’s terms, I would say it’s like a Tupperware dish that can contain pretty much whatever you want. It’s just a type of registration, a tax shell, and you choose the investments that will make up your TFSA. You can diversify as you see fit between segregated funds, guaranteed interest funds, high-interest savings accounts, daily interest funds and other investment options, such as investing in stocks, bonds or ETFs (exchange-traded funds). So you can put pretty much have whatever you want in a TFSA.
Ashleay: Okay. And what’s important to remember?
Sébastien: First: tax-free gains. Second: withdrawals whenever you like. Third: renewable space the year following withdrawals. Fourth: an asset for a short- or medium-term financial strategy to finance a project, maximize savings for retirement or create a small cushion, an emergency fund. All these needs are well suited for a TFSA.
Ashleay: All right. And what about RRSPs? How do they work?
Sébastien: Well, RRSP means Registered Retirement Savings Plan. It’s a savings plan set up by the Canadian government to help Canadians save for their retirement. What’s important to remember here is that the RRSP has a double tax advantage. The money that you invest is tax sheltered, so you can deduct your contributions from your initial income and pay less tax. And as long as you don’t make any withdrawals, the sums generated by your RRSP are not taxable.
Ashleay: What’s one word you’d use to describe the RRSP?
Sébastien: “Retirement” would be the word here.
Ashleay: Perfect. And what about contribution amounts, you know, limits and ceilings?
Sébastien: For 2023, Canadians can contribute up to 18% of their annual income for a maximum of $30,780 to their RRSP. Any unused contribution room accumulates from year to year, which means you could invest more than 18% of your annual income if you haven’t maximized your contributions in previous years.
Ashleay: Okay, and are there any mistakes to avoid?
Sébastien: There are always mistakes to avoid. I would say not taking advantage of maximum tax deductions over your lifespan, you know, taking advantage of the maximum every single year. The thing is, life happens: you may have kids or you may have to buy a house, for example, so the affordability of contributing to an RRSP shifts through time. But through your life it’s good to take maximum advantage of all the possible tax deductions. Another mistake is not sufficiently diversifying your investment portfolio. Even if it’s for the long run, if it’s for retirement, the basic principles of investing, of course, apply. On the fiscal side, withdrawing money too early is a mistake to avoid. Any withdrawal that you make before the age of 71 is subject to tax penalties and will reduce your potential retirement income. Avoid withdrawing money before you really need it. Ignoring your investment horizon is a very common mistake. You’re investing for the long run. But also, if you want to use your RRSP to buy a home and benefit from the programs available there, then you need to invest accordingly. Also, don’t ignore associated fees. You know, again, management fees can eat into your capital. And it’s not because it’s for the long run that you shouldn’t care about how your money is invested.
Ashleay: Absolutely. So is an RRSP right for everyone?
Sébastien: RRSPs are generally more effective for higher income earners who need to deduct taxes, since RRSP contributions reduce your taxable income. RRSPs are also more effective for those at the more advanced stage in their working lives and who have a long-term perspective on their savings and retirement.
Ashleay: Right, and younger people entering the job market or those with more modest incomes may opt for the TFSA—the Tax-free Savings Account—instead, since contributing to an RRSP won’t necessarily provide a tax advantage. And then there’s the newcomer, the FHSA.
Sébastien: So FHSA stands for First Home Savings Account. It’s a tax-free savings account for first-time home buyers, designed to help future homeowners save to make that purchase. It combines the advantages of the RRSP and TFSA. One word to describe the FHSA would be “property.”
Ashleay: And what are the contribution amounts?
Sébastien: You can contribute up to $8,000 a year to your FHSA for a lifetime maximum of $40,000.
Ashleay: Okay. And what are the key points to remember?
Sébastien: It’s a way to reduce your taxable income; it may entitle you to a tax refund. And for all the details, of course, we did a podcast earlier… though, I don’t remember the date exactly.
Ashleay: It was November 13, 2023.
Sébastien: Yeah, so there’s going to be much more detail there. I encourage everyone to give it a listen if you want to hear more.
Ashleay: Great. So Sébastien, if I had $10,000 to invest this year, what plan would I prioritize?
Sébastien: Well, that’s an excellent question. Every plan has its merits but they need to be used optimally. So it really depends; there’s no one size fits all. But let’s play the game. So let’s say you’re a 25-year-old. Well, you could prioritize the FHSA at $8,000 because the TFSA and RRSP offer the possibility of catching up to this limit eventually. And you could invest the remaining $2,000 in an RRSP. Then the tax return generated from that could be deposited in a TFSA as an emergency account. As you can see, you can kind of make all these products work together to get the maximum out of each of them. So there’s tons of scenarios to consider. But the important thing to remember is that to optimize the various plans every year, you need to think about how you want to distribute your investment liquidity among the different plans. This depends on your age, your financial situation, your objectives, your investment horizon, all of which will have an impact on the financial strategy you choose.
Ashleay: Right, so to sum up: the RRSP is best suited to retirement savings, the TFSA can be used for a variety of projects and it offers flexibility, and the FHSA is a combination of the RRSP and the TFSA for first-time homebuyers or for those looking for additional RRSP room. Well, that’s it. There are so many great options. Now it’s up to you to take action to achieve what you have in mind. Thanks for stopping by and please don’t hesitate to write to us if you have any questions or comments!