We often hear the saying: “You must save money to grow your wealth”. Everyone knows that, but not everyone does it.
There are tons of ways to “save” money that you can look up on the internet. Although, I realized that there is another related question that is a lot less obvious to find: Where do I keep the money I save?
Here in Canada, we have multiple tools that we can use to keep your money that is designed for “saving”. The two most popular ones are the retirement savings plan (RSP) and the tax-free saving account (TFSA).
What is an RSP?
This is a type of account that is registered with the government of Canada to hold savings or assets introduced in 1957.
When contributing to this account, the owner of the account gets tax benefits such as income reduction. The contribution limit increase is based on the previous year’s income declaration. As of the time of writing this, it is increased by 18% of your previous year earned income.
Any income generated from the assets within the account is nontaxable. In other words, straight to your pockets.
The downside is that the amount withdrawn must be added to your yearly income which will change the amount of taxes you will pay that year.
This idea behind this type of account is that if you contribute up to 18% a year, you will reduce your taxes to pay every year. This should help you over time because your income should in theory increase as the years goes by until you reach retirement, where your income would drop significantly. From that point, you should be able to withdraw from your RSP and get taxed from a lower income bracket.
What is a TFSA
Similar to the RSP, this type of account is also a registered account designed to hold savings or assets and save on taxes. This tool is much more recent than the RSP, it has been introduced in 2008 federal budget and became up and running January 1st 2009.
Unlike the RSP, the TFSA account contributions do not create an income deduction. You can consider any money contributed to this account as after-tax money. The contribution limit to this type of account is a fixed amount determined by the government every year.
Here are the yearly increases in CAD from 2009 to 2018:
- 2009 to 2012: 5000$
- 2013 to 2014: 5500$
- 2015: 10000$
- 2016 to 2018: 5500$
The contribution room start at 18 years old since the introduction of the TFSA. This means if you were 18 before 2009, you can contribute 57500$ in 2018. If you turned 18 in 2010, you missed 2 years of contribution increase, so you can only contribute 47500$.
Similar to the RSP, any income generated from assets within the account is tax-free. The greatest advantage from the TFSA is that you can withdraw whenever you want without any income penalties.
So in the scenario where you contribute to your TFSA and buy dividend-paying stocks, any dividends being deposited to your account could be withdrawn at any time without having to pay taxes on the amount.
There are many other rules around the two of them, but these are the main benefits to them.
Many people tend to push early on the RSP and wait before contributing to the TFSA. My strategy is different. On my side, I am pushing to max out my TFSA first. I know that on the short term, I will pay a bit more taxes, but the logic behind that is, that my income should in theory go up. This means that I will have to pay more taxes later on. If I keep my contribution room from my RSP to be used when my income is high, I should save a lot more taxes. I prefer paying taxes when my income is low than taxes when my income is high, it’s simple maths.
This strategy is not for everyone. In my case, I want to build enough assets first so it, covers my expenses before retirement. This does require patience and resistance against myself wanting to buy everything I see out there, but I know I will thank myself 10-15 years from now.
I hope you found some bits of knowledge here and there in this post. This should give you more options to answer the question “Where do I put the money I saved?”.
The next question is much harder to answer, “What do I do with the money I saved?”
I am far from being an expert to answer that question, but I’ve learned quite a few things that I’ve gathered for you to learn in my average investor guide.