How to Pick the Right Investment Account
April 28, 2016
Hello Voleo readers! We are Justin, Irvin, and Shun from Young Guys Finance. Our YouTube channel provides young Canadians with personal finance advice that won’t put them to sleep.
We’re really excited to share everything we’ve learned about investing with you guys. A few years ago, we were terrified of investing. We read all the books possible about personal finance before diving head first into it, and we discovered that there’s only so much you can read from a wall of text! We hope that by sharing our stories, we can encourage you to start your investing journey!
Over the next four weeks, we’ll take you through everything we learned about investing.
Week 1 (Today!) – Picking the right account for you: TFSAs, RRSPs, and non-registered trading accounts.
Week 2 – Investment Products Explained in 1 Minute: GICs, Bonds, Stocks, Mutual Funds, and Index Funds.
Week 3 – The Differences Between Active and Passive Investing
Week 4 – Building the Perfect Investment Portfolio
Picking the Right Account: Registered vs. Non-Registered
Before we can think about stocks, mutual funds, or other investment products, let’s take a step back. The first decision you want to make as an investor is which account to open up.
On a high level, there are two types of investment accounts: Registered, and Non-Registered.
We’re not going to dig into the details too much, but Registered accounts have certain tax advantages compared to Non-Registered accounts, and we recommend you open Registered accounts first. There are two types of Registered Accounts: Tax Free Savings Accounts (TFSA) and Registered Retirement Savings Plans (RRSP)
The Tax Free Savings Account (TFSA) was introduced 8 years to encourage Canadians to invest money for medium to long-term timeframes. It’s called the ‘Tax Free’ Savings Account because there are no tax implications with the money that you deposit into the account. Because the money you put in already has been taxed (whether it’s from your job or from other investments), there are no other tax benefits gained from contributing to it.
Each Canadian resident has a contribution limit based on their age, which means they are limited to depositing a certain amount into the account. As of 2016, that number is $46,500, if you were 18 years old in 2008. Every time the calendar hits January 1, the current annual contribution limit increases by a number determined by the Government. In 2016, that increase was $5,500.
With a TFSA, you’re able to buy most investment products. This includes GICs, bonds, stocks, mutual funds, and ETFs. We’ll get into those later.
When it comes time to withdraw from your TFSA, there are no tax implications. This means that you don’t pay any tax on any capital gains resulting from selling stocks or funds inside the account.
Because of its simplicity, the TFSA is usually recommended for people looking to start investing. It’s common for people to withdraw from their TFSA to fund their short to medium term goals such as travelling, buying a house, or buying a car.
The Registered Retirement Savings Plan (RRSP) is different to the TFSA in the way that there are certain tax implications when you contribute and withdraw from the account. These accounts were created with the purpose of allowing Canadians to save for their retirement.
Let’s take a minute to talk about how income taxes work. When you eventually graduate and start your first job, your employer will pay you a certain salary, let’s say $40,000 per year. The Canadian Government determines the tax rates, and for example will say that someone making $40,000 has to pay an average 25% in taxes. This means that you’ll have to pay:
$40,000 * 25% = $10,000 in taxes over the span of one year.
So every paycheque, your employer will take 25% of your salary and pay it to the Government.
Now, when you open up an RRSP and contribute to it, that amount DECREASES your taxable income. Let’s say you contribute (deposit) $5,000 into that account. Even though you’re making $40,000, your taxable income will DECREASE, meaning the Canadian Government is expecting you to pay:
$(40,000 – $5,000) * 25% = $8,750
But wait, you paid $10,000 in taxes already (as above). Well that means you paid too much tax! The Government won’t keep it though, which is how tax refunds are calculated. You can expect a $1,250 refund when it comes time to file your taxes.
RRSP contributions decrease your taxable income, but when it comes time to withdraw your money (when you’re old), the withdrawals are taxed! So when you withdraw that $5,000 later, you’ll have to pay tax, hopefully at a lower rate than 25%.
Similar to TFSAs, you’re able to buy most investment products. This includes GICs, bonds, stocks, mutual funds, and ETFs.
Still unsure of the differences? Check out our short video on the Differences Between a TFSA and an RRSP.
Check back for Part 2 of our series, we’ll go over the different investment products available to you as an investor.
Young Guys Finance is a website dedicated to teaching the essentials of personal finance for young Canadians. If you’re hungry for more, check out our videos at http://www.youngguysfinance.com!
Justin Lee is the host of Young Guys Finance. With an accounting degree from SFU and in pursuit of his CPA designation, Justin also has a weird mix of interests that include sneakers, coffee, and Kanye West.
Irvin Ho is the business and content developer for Young Guys Finance. He graduated from SFU with a BBA in Finance. In his spare time, Irvin plays competitive dodgeball in the Vancouver Dodgeball League, and ultimate in the Vancouver Ultimate League.
Shun Lee handles the experience design and multimedia production of Young Guys Finance. He graduated from SFU with a BA in Interactive Arts and Technology. Shun is a meticulous guy, obsessed with designing spreadsheets for all aspects of his life.