Investing for beginners: Explaining TFSAs and RRSPs

By Aneesh Chatterjee

Posted on October 4, 2021

Investing might sound like something only the super-wealthy are able to do, but this isn’t the case. Even if you’re not a stock trader or a real estate expert, you can still save for the future. Here are two ways you can start managing your money better using low-risk, long-term investments.

1. Open a Tax-Free Savings Account (TFSA)

If you’re 18 or older and have a valid Social Insurance Number in Canada, you can open a TFSA with your bank. This account lets you put away money whenever you want, which will not be charged income tax even when you take the money out.

Make a habit of contributing a certain amount of money every time you get your paycheck. This will not only increase your savings over time, but because it’s a TFSA, the money you put away will generate interest every year.
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Every bank, credit union, and insurance company has a different interest rate. The highest interest rate in Canada, offered by EQ Bank, is 1.25 percent per year.

If you deposit $1000 in your TFSA at the beginning of the year, it will generate 1.25 percent of 1000 and add that amount to what you initially deposited—which, in this case, is $12.5, leaving you with $1012.5 at the end of the year.

While this may not seem like much, the idea is that you keep contributing, not just depositing money once. The more you contribute, the higher your interest return will be. You can also withdraw any amount whenever you wish without paying any taxes on it.

While you do earn interest on your deposits, the most important lesson here is learning to save money. Getting into the habit of putting away even a small amount on a regular basis will give you more financial stability in the long term.

After paying your bills, utilities, buying essentials, like groceries, gas for your car, and other supplies, consider how much money you have left and put a chunk of it away in your TFSA. You can then leave the rest for general day-to-day spending. Do this every second week or every month for a few years. Eventually, you will look back on a substantial amount of saved money that can help you in emergencies, help you avoid some debt, and give you some degree of financial freedom.
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2. Open a Registered Retirement Savings Plan (RRSP)

Like the TFSA, an RRSP is an account you can open with your bank which lets you contribute money towards your future. Any amount you put in your RRSP also generates interest the same way a TFSA does. EQ Bank currently offers the highest interest rate for an RRSP, also at 1.25 percent per year. The amount you contribute, and the interest gained over time, is also tax-free. There are some differences, however.

Unlike a TFSA, the money you put into your RRSP will only be tax-free as long as you keep it in the account. If you withdraw it from your account at any point, you’ll be charged the appropriate income tax amount. This amount can sometimes be a very large tax bill depending on how much you withdraw and where you live in Canada. This page shows a breakdown of the tax rate for different withdrawal amounts if you decide to take money out of your RRSP early.

However, there are different tax benefits to opening an RRSP. The amount you contribute is tax-deductible, which means the amount can be deducted from your taxes every year. This is an excellent way to gain some tax relief in the shorter term while you put away money for the long term!

There is, however, a limit to how much you can contribute to an RRSP. It’s set to 18 percent of your annual income, or whatever the year’s current limit is—in 2021, it’s $27 830. This means that if 18 percent of your annual income is less than $27 830, you can contribute the full 18 per cent. If your income is high enough that 18 per cent is more than $27 830, you won’t be able to use the full 18 per cent to contribute and get tax deductions.

The withdrawal age for RRSPs is 71 years. You must close your RRSP no later than December 31 of the year in which you turn 71 years old. At this point, you would withdraw the full amount of however much you contributed since you opened it. This amount is still subject to withholding tax, and the full amount is considered income. That means it’ll be subject to income tax as well.

Other ways to access your RRSP

For many people, converting an RRSP into an RRIF (Registered Retirement Income Fund) is a viable option when they turn 71, instead of withdrawing the full amount right away.

There are also ways to withdraw some of your RRSP before turning 71 and not be charged heavy taxes on it. These are called the Homebuyer’s Plan (HBP) and Lifelong Learning Plan (LLP). Both are tax-free, interest-free loans you can take from your total RRSP, which you will then have to pay back over 10 or 15 years.
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The HBP allows you to take up to $25 000 from your RRSP, without being taxed, if you’re buying your first home and you need to put in a down payment. You’ll have to pay back the $25 000 over the next 15 years, starting in the year after you borrowed. Similarly, the LLP lets you borrow $10 000 from your RRSP to use for training and education. You’ll need to pay this amount back over 10 years, starting five years after you borrow.

As you can see, an RRSP is more complex than a TFSA and takes some time and research to learn what you can do with it. Even so, it’s important to save money for your retirement, even if it seems far away right now. Taxes can be heavy on how much you eventually take out, so the earlier you start, the more money you’ll have at the end.

More ways to save

This is not the only way you can generate income and secure your future outside your regular paycheck. There are many ways to invest, including stocks, mutual funds, Guaranteed Investment Certificates, real estate markets, and more. These range from low to high-risk, and it really depends on how much you want to invest and what your goals are. Whatever the case is, always remember to talk to a professional advisor from your bank before going into any long-term plans.

For more information on easy, low-risk options for saving your money, check out The Newcomer’s Guide to savings accounts in Canada.

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