Make Tax Planning Part of Your Retirement Investing Plan

For Canadians, there are three primary retirement investment vehicles: the RRSP, the TFSA, and non-registered accounts.

There are huge tax implications.

First, Registered Retirement Savings Plan (RRSP) is a tax-advantaged investment account available in Canada. It allows individuals to save for retirement by contributing pre-tax income, which is then invested in various financial products such as stocks, bonds, and mutual funds. RRSP contributions are tax-deductible, meaning they reduce taxable income and provide immediate tax savings.

However, withdrawals from an RRSP are considered taxable income, and depending on how much you withdraw, your financial institution will automatically put aside a "withholding tax" to send to the CRA. However, depending on your marginal tax bracket, it may not be enough to covered your taxes owed due to the withdrawal.

Also, your RRSP contribution room is tracked by the CRA (you can check online on your account). If you are out of contribution room, and you withdraw, say, $10,000, you lose that $10,000 of contribution room. So withdraw wisely.

Second, non-registered investment accounts (sometimes called "brokerage accounts") are not tax-advantaged, meaning contributions are made with after-tax income. While they do not offer the same immediate tax benefits as RRSPs, non-registered accounts provide greater flexibility in terms of contribution limits, withdrawals, and investment options.

However, and this is key, any capital gains, dividends, or interest income earned in a non-registered account are subject to tax each and every year in which they occur. In many cases, investing in mutual funds involves the fund manager buying and selling various holdings in the fund throughout the year. This can trigger capital gains, which are taxable income, even though you didn't withdraw a penny from your investment account. If you invest in any dividend stocks or funds, any dividends issued throughout the year are also taxable income, even if you didn't withdraw a penny from your account.

In short, we advise not holding actively managed mutual funds or any dividend producing products in a non-registered account. You should not be opening yourself up to paying tax on investment gains even when you don't withdraw from your non-registered account.

Here comes the TFSA to save the day. The Tax Free Savings Account (TFSA) is an amazing investment vehicle that is tax-advantaged like the RRSP, but your contributions are made with after-tax dollars (your contributions are not tax deductible). This means any withdrawals are not considered income. Also, any capital gains, dividends, or interest income earned within a TFSA are tax free. Even better, if you withdraw that hypothetical $10,000, your total TFSA contribution room isn't diminished.

We advise maxing out your TFSA before putting a penny into a non-registered plan. And avoid any investments that could trigger capital gains, dividends, or interest income in a non-registered account, because you'll be paying taxes you otherwise wouldn't.

At Friendly Fox Tax Services, we're able to advise you on the tax implications of your investment strategies. We aren't financial planners, but we can help show you the tax implications of your options.