You’ve decided you’re ready to start investing. What now? 

First you have to decide what you’re investing for. Different account types are designed to help achieve different objectives so having a clear goal will help to narrow down your options. The account type you choose will determine how much you’re allowed to contribute, and how the money you contribute and earn within the account will be taxed. 

Let’s take a look at some of the more common types of investment accounts:  

General Investing Accounts

TFSA (Tax-Free Savings Account) – an account in which contributions and investment income grow tax-free and from which withdrawals are also tax-free. To be eligible to open a TFSA you have to be resident in Canada and age 18 or older. Contribution room is limited based on the number of years the accountholder has been over 18 and living in Canada since 2009. Any unused contribution room can be carried forward. When you make a withdrawal from your TFSA that contribution room is returned to you in the following year. Overcontributions to a TFSA are subject to an overcontribution penalty of 1% per month.  

RRSP (Registered Retirement Savings Account)– a retirement savings vehicle for employed and self-employed Canadians. Contributions to an RRSP are tax-deductible and grow tax-free until they are withdrawn, at which point they are taxed as income. The intent of the RRSP is to defer income tax until retirement, when you would presumably be in a lower tax bracket (although this isn’t always the case). RRSP contribution room is calculated on an individual basis as a percentage of income (18%). Unused contribution room can be carried forward until age 71. Contributions to a work pension plan will reduce your RRSP contribution room. While the intended purpose of the RRSP is to build retirement savings, you can withdraw from your RRSP at any time. Overcontributions are subject to the same overcontribution penalty as TFSAs (ie: 1% per month).

Non-Registered Savings Account – a taxable investment account that is available to all Canadian investors. The term non-registered simply means it is not registered with the Canadian federal government (as opposed to TFSAs and RRSPs which are registered accounts). There is no limit to how much you can contribute to a non-registered account. Investment income is taxable in the year it is earned and additional taxes may apply when money is withdrawn from the account. We’ll talk more about how different types of investment income are taxed in next week’s newsletter. Non-registered accounts are most often used after TFSA and RRSP contributions are maxed out, or for investing inside a corporation. 

Special-Purpose Investment Accounts 

FHSA (First Home Savings Account) – designed to help qualified first-time home buyers save up a down payment. Contributions are tax deductible and withdrawals are tax-free. There is an annual contribution limit of $8,000 and a lifetime limit of $40,000. 

RESP (Registered Education Savings Account) –  designed to help save for a child’s postsecondary education. Contributors do not receive a tax deduction on contributions and withdrawals of capital are tax-free. Contributions up to $2,500 per year are eligible for the Canada Education Savings Grant (CESG) which is equal to 20% of the total contributed. Withdrawals of investment income and grant income are taxable but can be taxed in the hands of the student beneficiary who presumably would have a lower marginal tax rate. There’s so much more to know about RESPs that we’ll be covering in depth in the coming months! 

RDSP (Registered Disability Savings Plan) –  a registered matching savings plan specifically for people with disabilities. Depending on personal income, contributions can be eligible for the Canada Disability Savings Grant and Canada Disability Savings Bond. Anyone can contribute to an RDSP on behalf of the accountholder. RDSPs are complex. If you feel that you or someone you know might be eligible contact your financial planner. 

Choosing an Investment

Choosing an investment is different from choosing an account. Remember, the account type you choose determines how much you can contribute and how you will be taxed on your contributions, withdrawals and investment income. In addition to this you also have to decide how you would like the money within the account to be invested and for that, you have a lot of options. Here are some of the most common ones: 

Cash – when you’re holding cash it means you’re not invested. Think savings accounts at your local bank branch. These institutions will typically pay a small amount of interest on your cash holdings, but this return is often much lower than the rate of return on other types of investments. 

GICs/GIAs (Guaranteed Investment Certificates/Guaranteed Interest Accounts) – an investment sold by Canadian financial institutions. Investors deposit money in the institution for a fixed length of time (ie: the term) in exchange for an interest payment that is contractually agreed to upon purchase. Cash and GICs are the least risky types of investments and because of this tend to pay less interest than other, riskier investments (more on this in week 3).

Stocks/Equities – represents a share in the ownership of a company, including a claim on the company’s earnings and assets. Stocks are generally bought and sold electronically through stock exchanges but can also be purchased in bundles known as “funds.” Generally speaking, stocks are a riskier investment than GICs or bonds. When stocks are held in a fund they are commonly referred to as “equities”. 

Bonds/Fixed Income – bonds are issued by governments and corporations when they want to raise money. When you buy a bond you are loaning your money to the issuer for a set period of time, in exchange for periodic interest payments. When bonds are held within a fund they are commonly referred to as “fixed income.” 

Mutual Funds – a mutual fund is a portfolio of stocks, bonds or other securities that are selected and managed by a professional fund manager. When you invest in a mutual fund your money is pooled with that of other investors and used to purchase units or shares of the fund. Profits and losses of the fund are passed on to investors according to the number of units or shares that you own. 

Segregated Funds – segregated funds are similar to mutual funds in that investments are pooled and then managed by a fund manager in exchange for a fee. The most notable difference between segregated and mutual funds is that segregated funds include some insurance guarantees that can protect some or all of your original investment. These guarantees can help reduce an investors risk of losing money, but it comes at a cost in the form of higher management fees. 

Exchange Traded Funds (ETFs) – ETFs are similar to mutual funds as well in that they provide a way for investors to buy into a preselected basket of securities, however ETFs tend to be passively managed, meaning rather than rely on a team of fund managers to make investment decisions ETFs are designed to mimic an underlying index, such as the S&P500. 

Not to make things overly confusing but it’s worth noting that the lines between mutual funds and ETFs are becoming increasingly blurred, as some mutual funds track an underlying index, and some ETFs are actively managed. We’ll dig into this more next month as we talk about how to choose the investment that’s right for you. 

Now that you know the difference between account types and their underlying investments you can see how it’s possible that one person can have a TFSA at their bank branch that holds cash while another person could have a TFSA with their investment advisor that holds mutual funds. With so many options, how can you decide what’s right for you? Step one: stay tuned for next week’s newsletter where we’ll take a look at rates of return and the different ways you can get paid on an investment. 

Have a question? Leave it in the comments or contact me HERE.