Friday, January 21, 2011

Tax time! RRSP or TFSA?

It's almost that time of year people...  when you have a chance to file some tedious paperwork and fight/claw/scratch back a few dollars of your hard earned income from the the Canada Revenue Agency (CRA).  The adverts on TV most certainly want you to maximize your Registered Retirement Savings Plan (RRSP) contributions for your retirement.  This isn't wholly a bad thing, but if you're like me the benefits of the contribution don't really add up to much.

Remember: contributing to your RRSP only lets you procrastinate paying your taxes.  You'll have to pay the tax when you need your RRSP money to live off of when the Old Age Pension (OAP) and the Canada Pension Plan  (CPP) have dried up.  Don't get me wrong, I'm not a tin-foil-hat wearing doom-and-gloom professing the end-is-nigh wacko.  I'm hoping OAP and CPP will still exist when I need them, but I'm making sure my lifestyle (as humble and meek as it is) won't be too heavily impacted by their collapse.  Plus, if you're a starving artist like me your income now is much lower than it will be when you retire.  So chances are you will be paying more tax when you need your RRSP money than you would pay now.  That being said, yes, the tax shielding inside the RRSP is a good thing, but before you fill up your RRSP, please consider the Tax Free Savings Account.  (TFSA)

The most brilliant gift from CRA in a long long time is the TFSA.  Please don't be fooled by the big banks and those online operations that have higher rates on savings accounts.  The TFSA can be more than just a pedestrian savings account.  It can also be a brokerage account and yes you can day-trade in it if you see fit!  ALL of the monies earned through capitol gains, dividends, distributions and interest is 100% tax free.  NO TAX will be deducted when you take the money out of this plan.  Thus any profits you make are FREE MONEY!  

I can hear you shaking your heads...  investing isn't for me!  I say pshaww!  It most certainly is!  If you're young you have the most to gain from contributing.  My goal with this blog is to help you understand some basics and eventually some more advanced techniques to help you live a long, happy life without having to worry about income.  However, the focus of today's post isn't investing techniques, it's about tax advantages and account types.

Once you fill up your TFSA then any money left over should be used for your RRSP.  Alternatively, you might consider investing in a CASH account.  Cash accounts are NOT registered so any money you make is subject to capitol gains tax or income tax or taxable interest income.  Which for the low income investor isn't as bad as it sounds.  Example:  Say you purchased 100 shares of ACME Widgets Inc for $10 per share.  ACME had a bumper year selling items to Wylie Coyote and their stock went up 100%.  You're $1000 investment is now worth $2000.  Do you owe any tax?  As long as you continue to own those shares you won't have to pay any taxes.  But when you sell them, then you will be responsible for reporting the sale in your tax return.  (The brokerage won't report anything to CRA)  The good news is that you only owe capitol gains tax on 50% of the gain and only at the tax rate of your current income bracket.  So if you sold your shares for $2000 you made a profit of $1000.  Since you only have to pay tax on half of that at your margin rate you would only owe $75 or $125.  (Current lowest 2 tax rates in Canada for 2010 year).

Please note my figures are VERY approximate and I'm streamlining things a lot.  Your accountant (or tax software) will need to know the name of the company you sold, how many units, your average purchase price and how much you sold it for.  This does involve a bit of busy work but it sure beats an audit from CRA!  Also, one other item to know, if you're trading in a registered account (TFSA, RRSP etc.)  Then you don't have to do any of this tedious reporting.

In summary, if you have anything to invest (even $25 a week... even $25 a month!) it really does pay to fill up your TFSA and get it working for you!

Lastly: I'm not a tax accountant.  Do NOT take my rough figures as gospel!  By reading this you have agreed to not sue me for my over-simplification of taxation.  And finally if you lose all your money and then some it's not my fault.  You just have to accept responsibility for your own actions people!  

Next time: I'm 25, single and hoping to get a better job...  Why should I invest now?  I'm going to be making more money in the future so won't that be better to wait?

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