How to use RRSPs, TFSAs and more to save on taxes and get 'free' money

Jamie Golombek: Here’s how to prioritize contributions to registered savings plans to eliminate, or at least minimize, taxes on investment income

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There’s an alphabet soup of registered plans now available to Canadians, so a question that regularly comes up in nearly all financial planning conversations is how to prioritize contributions to the various plans to eliminate, or at least minimize, taxes on investment income.

This is even more relevant in 2023, since some investors have taken a renewed interest in guaranteed investment certificates since rates can exceed five per cent, but generate fully taxable interest income. With top personal marginal rates as high as 55 per cent (Newfoundland and Labrador) in 2023, optimizing contributions to registered plans to eliminate tax on investment income has never been more important.

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Before laying out my prioritization preferences, let’s take a brief look at each plan and the 2023 limits and amounts.

Registered retirement savings plans

Of all the registered plans, the RRSP has been around the longest and is certainly the most well-known. For 2023, tax-deductible RRSP contributions can be made up to 18 per cent of the prior year’s (2022) earned income, up to a maximum contribution of $30,780. Taxes are deferred on any income and growth while funds are held within the plan. Tax is only paid when the funds are withdrawn from the RRSP, or its successor, the registered retirement income fund (RRIF) or annuity.

Tax-free savings accounts

Introduced in 2009, the TFSA works like an RRSP, but in reverse. Although contributions made to a TFSA are not tax deductible, no tax is payable on income and growth, or on withdrawals. TFSA contribution room carries forward indefinitely from year to year such that if an individual is at least 32 years old in 2023, and has been a resident of Canada since 2009 but never contributed to a TFSA, they could contribute $88,000 in 2023. The 2023 limit is $6,500.

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Registered education savings plans

An RESP allows individuals to save for their child’s post-secondary education by contributing up to $50,000 per child. The plans became extremely popular in 1998, when the government introduced the Canada Education Savings Grant (CESG), which is equal to 20 per cent of total annual contributions, generally up to a maximum grant of $500 per year, per child under age 18, with a lifetime limit of $7,200 per child.

Tax is deferred on investment income earned within an RESP. RESP earnings, growth and CESGs are included in income of the student beneficiary when they are paid out for post-secondary education purposes. By claiming the basic personal amount ($15,000 in 2023) along with federal tuition credits, the student may ultimately pay little or no tax on the RESP withdrawals.

Registered disability savings plans

If you or someone in your family has a severe disability that allows them to qualify for the disability tax credit (DTC), it’s worth considering the RDSP. These plans are designed to help build long-term savings for individuals with disabilities. Individuals may contribute up to $200,000 on behalf of a beneficiary who qualifies for the DTC. There is no tax on earnings or growth while in the plan.

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In addition to the power of tax-deferred compounding, Canada Disability Savings Grants (CDSGs), with a lifetime maximum of $70,000 per beneficiary, and Canada Disability Savings Bonds (CDSBs), with a lifetime maximum of $20,000 per beneficiary, may be received up until the end of the year in which the beneficiary turns 49, depending on family income.

Original contributions are not taxed when disability assistance payments are ultimately made to the beneficiary, but earnings, growth and government assistance are included in the beneficiary’s income. As with RESP withdrawals, if the beneficiary has zero or minimal other income, the basic personal amount combined with the DTC may allow most or all of the funds to come out of the RDSP tax-free.

First home savings accounts

Finally, the FHSA for first-time homebuyers was introduced in 2023 and is the newest registered plan. The FHSA combines the benefits of both the RRSP and the TFSA because contributions are tax deductible, and income earned is not taxable while in the plan, nor taxable when withdrawn as long as the funds are used to buy a first home within 15 years. The annual contribution limit is $8,000, up to a total maximum limit of $40,000.

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Which plan to prioritize?

Assuming you don’t have enough extra cash annually to maximize all your registered plans, here are some things to consider as you prioritize your contributions. My general advice is to go for the so-called free money first.

If you or a family member has a disability, contribute first to an RDSP, which can provide up to $90,000 in grants and bonds, depending on the age of the beneficiary and family income.

If you’ve got kids, I would then prioritize the RESP by contributing at least $2,500, per kid, per year, to get the CESG match of 20 per cent, which can add up to $7,200 per child of free money deposited into the RESP.

Then, if you’re a first-time homebuyer, put $8,000 into an FHSA, since there’s a tax deduction on the way in and no tax on the way out. There’s no downside if you don’t end up buying a home. You can simply move the funds over to an RRSP without using up contribution room.

With any excess funds, consider your short-, medium- and long-term savings goals.

For example, if your goal is to save for a wedding reception or a home renovation in a few years’ time, perhaps the TFSA is your best vehicle.

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On the other hand, if your goal is long-term retirement savings, choosing between an RRSP and TFSA comes down to your tax bracket today versus your expected tax rate in retirement. If you’re in a higher tax bracket now than you expect to be in when you retire, prioritize RRSP contributions over TFSAs. If you’re in a relatively low bracket today, TFSAs may be your best option.

Jamie Golombek, CPA, CA, CFP, CLU, TEP, is the managing director, Tax & Estate Planning with CIBC Private Wealth in Toronto.

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