The 2023 tax deadline has officially come and gone. Some made it out with a heavy tax bill, and others did not. How did you do?
If you found yourself paying more tax than you would have liked, you might wonder how to prepare for next year. It starts with understanding your investment accounts and how to leverage them to pay less tax. Perhaps it may not zero out your amount owing, but it can make a big impact when leveraged correctly.
Investment contributions are an essential part of your wealth-building strategy. Although many different investment accounts exist, individuals often use their registered accounts first as they have the most significant tax benefit. Once you have a good idea of the characteristics of each one, you'll have a better idea of how you can make them work for you.
In this post, we will explore the main types of registered investment accounts, and we'll discuss what, if any, tax advantages exist for each one.
Types of Registered Investment Accounts
Registered Retirement Savings Plan (RRSP)
A Registered Retirement Savings Account (RRSP) is a tax-advantaged account designed for individuals saving for retirement or purchasing their first home. The maximum annual contribution amount is based on the salary of the individual.
Details regarding your contribution room can be found on your Notice of Assessment. If you don’t contribute to your RRSP each year, the annual contribution amount is carried over to the following year. It’s important to be aware that over-contributing to your RRSP can result in penalties, so it’s important to ensure that you understand how much contribution room you have remaining.
RRSP contributions made by you or your spouse are tax-deductible, which means you can reduce your taxable income by the amount contributed in a calendar year. This can result in significant tax savings, especially for high-income earners.
Although provisions exist for withdrawing monies for purchasing your first home, withdrawals from RRSP accounts are subject to taxes. It's important to note that you lose contribution room if and when you withdraw money from your RRSP. This type of account is best for individuals looking to gain returns on their investment over a more extended period.
A RRSP account automatically converts to a Registered Retirement Income Fund (RRIF) in the 71st year. RRIFs are designed to provide income during retirement, but there are minimum withdrawal requirements. RRIFs are similar to RRSPs in that contributions are tax-deductible, and withdrawals are taxed at the individual's tax rate.
Tax-Free Savings Account (TFSA)
A Tax-Free Savings Account (TFSA) is a tax-advantaged investment account created in 2009 for individuals over 18. Each year, an individual can contribute a fixed amount tax-free, and the contribution amount varies by year.
Unlike an RRSP, TFSA contributions are not tax-deductible, but withdrawals are unlimited. If you wish to remove money from the account, you will not lose the contribution room, and any unused contribution room will carry over to the following year.
It’s important to note that it is possible to lose your contribution room if you withdraw your funds at a loss because of market depreciation, for example.
TFSAs are ideal for those who want to earn investment returns while saving money for emergencies or short-term goals. Please speak to a professional for further information regarding your contribution room and your specific situation.
Other Types of Investment Accounts
There are a few other types of investment accounts, such as unregistered ones and the First Home Savings Account (FHSA), new as of April 1, 2023. The FHSA is a mix between a TFSA and an RRSP, as it has the tax advantages of an RRSP but the withdrawal flexibility of a TFSA.
The FHSA is designed to help first-time home buyers save for their first home tax-free. It's important to note that the money in this account can only be withdrawn to purchase a first home. The funds can also be transferred to an RRSP account.
Understanding the tax advantages and disadvantages of each type of investment account is imperative to craft a strategy that is right for your situation.
It’s possible that with the correct strategy and contributions, you could potentially pay zero dollars in tax. If you’re working with a bookkeeper or accountant ahead of time, it’s possible to ask them to calculate how much you'd have to contribute to your RRSP before the RRSP deadline (at the beginning of March) to minimize your tax bill.
This way, you're reducing your taxable income and paying yourself instead of having a high tax bill. Speaking to a professional about this subject can go a long way to saving you money on your income taxes.
A Little Bit of Learning Can Pay You Dividends
A basic understanding of how your investment accounts work can be a great advantage when saving money come tax time. Whether you're looking to save for retirement or looking to save for the short term, it's essential to know the implications of each type of account.
A professional accountant or bookkeeper can also help you strategize your investment contributions throughout the year to get the most bang for your buck.
It’s worth minimizing your stress by taking the time to learn more about the income tax advantages that are available. It may even cause you to start enjoying tax season. It’s all part of the essential game to building wealth.
Should you have questions about your investment contribution strategy, please do not hesitate to contact us today for more information. We can assist you in figuring out your contribution room for each account and assist in helping you leverage these accounts to their highest ability.