Monday, March 12, 2012

Getting Started, Part 3

continuation from Getting Started, Part 2

Registered Retirement Savings Plan (RRSP)

The RRSP is the center of Canadian retirement planning. This program was introduced in 1957 and is a very popular program in Canada.

The general idea behind the RRSP is to defer taxation from peak earnings years, where marginal tax rate is high, to retirement years, where marginal tax rate could be lower. It is important to note that the RRSP does not reduce your taxes, it simply defers them to what we hope is a time period where our marginal tax rates are lower (retirement) than originally (when we make the contributions).

Similar to TFSA, income and capital gains inside this account are not taxed at present time. However, income received from businesses based in certain countries may have a non-recoverable withholding tax. Fortunately, USA is not one of them, and has a tax treaty with Canada.

This account has a limit that is dependent on your earned income in the previous tax year. The RRSP contribution limit in any given year is defined by the sum of 18% of your earned income in the previous year and any previously unused RRSP contribution room. Most people are very aware of this already.

For example, at the start of 2011, James has $5000 unused RRSP room from the previous year, and his earned income in the previous year (2010) was $50,000. That means his 2011 RRSP contribution limit is $14,000 (5000 + 0.18 * 50000)

What many do not realize is that one caveat of the RRSP is that you must convert your entire RRSP into an RRIF by December 31 of the year you turn 71. Upon which you will be required to make mandatory minimum withdrawals each year. This caveat makes for some interesting tax scenarios, should you be fortunate enough to have a large RRSP upon retirement, since the annual withdrawal amount counts as income and is taxable.

That brings us to the last type of investment account

Non-Registered Brokerage Account

The main advantage of a non-registered account is the lack of limitations (contribution/withdrawal limits and tax treatment limits). In my opinion, for a young investor, this may not be necessarily valuable, but as your total net worth increases, the non-registered account becomes more and more valuable to avoid the large RRIF withdrawals later in life.

The downside is you are immediately liable for any capital gains or income in the current tax year.

All these things just mean that tax planning is a very important part of wealth building. As an investor, we need to at least somewhat understand the tax code to make decisions that do not hurt us in the long run.


All investment accounts typically have a minimum balance that is required before they waive the annual maintenance fee. On top of that, each transaction (buy or sell) will incur fees depending on your overall account value. BMO for example charges $29 per transaction if your account value is below $50k, but only $9.95 if it is above $50k. The $50k can be from a combination of accounts. If your parents have accounts they can link with yours, that makes getting $50k quite easy.

Depending on whether you decide to purchase securities (stocks) denominated in USD or not, you may also incur foreign exchange (FX) fees. These fees will be hidden and charged as part of the difference between the FX rate the bank gives you, and the spot rate. In a later article, I will go over one of the best currency conversion methods, a common strategy to avoid FX fees.


So based on all these information about various accounts, I use the following taxed based account allocation:

TFSA: US/CAD medium term capital gains investments first, then CAD long term dividend growth investments
RRSP: all US long term dividend growth investments
Non-Reg: remaining Canadian or US equities that cant fit in TFSA and RRSP, and any foreign equities

How you position your portfolio will depend on your situation, but I think this is at least a good starting point on which type of investments are favorable for which type of accounts :)

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