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How To Choose Which Account To Invest From

A reader asked a very good question as to how I decide which account to select when investing. I do have some guidelines and rule of thumb based on

  • How much money I can invest
  • How long I will invest it
  • Where I am at with my diversification
  • Where I stand with the limits allowed for some accounts
  • How I will be taxed on the investment

How to avoid paying the tax man any more money than I need to is probably at the top of my filter :). To achieve optimal tax efficiency, you need to understand the tax implication of the different accounts available. I also recommend that you use an up-to-date tax software program, such as TurboTax Canada, to give you step-by-step guidance until you’re ready to file.

Account Tax Treatment

The following accounts represent the most common categorization for investment accounts.

Taxable Account / Non-Registered Account

This is the most common account which can range from a mutual fund account at the bank to an employee stock purchase plan (ESPP) account with your employer. It refers to any accounts when the income and / or capital gains are taxed. All of my DRIP investments with CIBC Mellon and Computershare belong to this type of account.

If you want to be technical, all your bank accounts fall in this category. If you don’t much interest, you never get a tax form but if you were to earn enough interest the bank would send you a tax form to declare your earning.

TFSA – Tax Free Savings Account

This account is fairly new for Canadians. Three years ago, we had the honor of having the ability to invest $5,000 per year in a TFSA where all investment earnings, dividends, or capital gains is tax free. I won’t go into the details of the TFSA. If you want the details, the Canadian government has setup a site dedicated to it. The two main points are:

    • You can only add up to $5,000 to the account per year
    • All earnings are tax free

RRSP – Registered Retirement Savings Plan

Introduced in 1957 (as per Wikipedia – I wasn’t around :) ), the RRSP is a tax deferred account. Not to be mistaken with a tax free account. It means that your taxes are deferred to a later time. I won’t go into all the little details of the plan but essentially, you get a tax refund on any money you add to the account, and pay taxes on your withdrawal. While your money is in the account, your investment earnings are all tax free. You essentially get tax free growth while your money is in the account.

The RRSP account deserves a post on its own but that’s not for today. You’ll have to satisfy yourself with Wikipedia or the Canada Revenue Agency details. The goal of the RRSP account is to promote savings for retirement.

RESP – Registered Education Savings Plan

This purpose of this account is to promote savings for post-secondary education. Just like the RRSP, your investment grow tax free but you don’t get any tax refund when you add money to it. Instead, the government contributes 20% to a maximum of $2,500 per year per children. You must have children (one or more) as the account is registered in their names and you have an age limit.

There are many rules around adding to the account or withdrawing that I won’t cover them here. Instead, I’ll highlight a RESP book from a fellow blogger: The RESP Book: The Complete Guide to Registered Education Savings Plans for Canadians

If you are hungry for some government literature, they have some RESP legalese for you.

Account Selection Guidelines

Now that you understand the basic of the different accounts from a summarized tax treatment, selecting an account is a matter of being tax efficient for your investments. For me, maximizing my TFSA takes priority over my RRSP. For some, it’s the opposite. I don’t believe there is a clear winner as everyone’s situation is different. How you plan on retiring may also have an impact on your decision.

Since I am predominantly a dividend investor, my focus for this post is around dividend investments and my organization around the tax efficiency. Aside from the accounts, you also need to understand the tax treatment on foreign investments as they don’t necessarily follow the Canadian rules. For example, dividend income from US corporation will withhold taxes on your dividends which lowers the amount you get. I have also been setting up investments with CIBC Mellon and Computershare as you have seen from my Dividend Income reports.

1. Transfer Agents Setup

I have highlighted the benefits of having investments with the transfer agents as it allows you to:

    • Start with only 1 share and a very low fee of 10$
    • Add small amounts to your investments regularly
    • Benefit from the fractional shares
    • Benefit from the dividend re-investment discount

My filter for those investments as you can see in my monthly dividend report is around companies that provide a necessary service such as banks, utilities and telecoms (not a necessary service but we just can’t live without them). I get companies that I feel I can invest in without monitoring the price, and simply letting them average out over the years. Aside from REIT, they all generate dividends that are taxed efficiently in a non-taxable account.

2. TFSA Maximization

I always maximize my TFSA contribution if I can. So far I have managed to maximized mine but not my spouse. So I am a little behind from a family finance point of view. I do not buy US dividend companies in this account as I cannot maximize the dividend re-investment capabilities due to the tax withheld. DRIP is important for compound growth.

3. RRSP Optimization

I have 2 RRSP strategies due to my employer’s define contribution plan. I do regular contribution to my RRSP through my employer’s plan and then I manage my self-directed RRSP with my broker. I had a number of mutual funds in the past that I have sold to buy dividend investments. This is the account where I hold my US dividend paying investments as we have a treaty with the US for the RRSP account where taxes are not withheld on dividends. From a tax perspective, anything in a RRSP account grows tax free until withdrawal time. What’s important is how you plan your withdrawal and what your income expectation are at such time.

4. RESP Investments

I started with mutual funds and I am still with mutual funds. Due to the small amounts added monthly, mutual funds is what made sense from a fee perspective. You could have the ability to put in a lump sump and buy stocks if you want. It really depends on your budget. I don’t plan on making changes with it.

Readers: What is your filter order for deciding on where to put your money?

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12 Responses to "How To Choose Which Account To Invest From"

  1. SirTie says:

    Great post!
    Could you clarify something, is it possible to have a TFSA with CIBC Mellon and Computershare? So that dividends stay tax free?

    • The Passive Income Earner says:

      @SirTie

      So far I don’t believe it’s possible to have any types of account other than a non-registered account.

      • SirTie says:

        In your opinion, do you think that this is a major disadvantage of investing through transfer agent? Since with a broker you can setup TFSA with automatic dividend purchase plan (DPP) with no cost.
        My current thinking is to buy just enough shares so that each dividend payment can automatically buy you at least one additional share, any thoughts on this?

        • The Passive Income Earner says:

          It should be part of your overall strategy. For me, I have 11 companies with the Transfer Agents and I add money every now and again. I have a spreadsheet that shows me which one is out of favor so I can add more but generally speaking, I am not market timing my purchases. I add $100 to $250 at a time. I find it’s easier to save that much every now and again as opposed to accumulating large sum in a separate account. I also have the trading account where I am setup with TFSA, RRSP and non-registered trading. I do $5K in my TFSA every year usually in a lump sum and then I manage it that way. I do not have fractional shares though so as the stocks go up, I may not be able to purchase. I also tend to not buy the same companies in my TFSA, RRSP and Transfer Agents due to the fact that I want to leverage my non-registered Transfer Agents and diversify in my other accounts. I’d say that I have all the holdings I want and need with the Transfer Agents. I just need to add funds to them every now and again and let them work their dividend magic with DRIP (discount + fractional shares). With the Trading Accounts, I diversify and pick investments not available with the Transfer Agents.

          Thanks for the question, hope it helps!

  2. Derek says:

    Hello PIE,

    I was wondering if I should utilize my employee’s shareholder plan to the maximum so that I could collect the dividends consistently. Receiving shares at a discount would be perfect for dividend / retirement investing, right?

    • The Passive Income Earner says:

      Hi Derek,

      Thanks for stopping by. ESPP is a great benefit from employers. You should maximize the benefits but always look at it as an investment part of your portfolio. It can be dangerous to have all your eggs in one basket. I sell mine right away (there is no dividends either). Make sure you define how much you want to hold as part of your diversification and scrutinize your employer from an investment perspective the same way you would scrutinize all other investments.

      Hope this helps.

  3. Ossa Zebian says:

    ok, all my questions are basically answered. THE BEST DAMN SITE, THANK U PASSIVE INCOME EARNER …..

  4. Derek says:

    Hello,

    I was wondering what you think of ETF’s versus Mutual Funds in the RRSP account? Do you have any recommendations for ETF’s.

    Also what type of investments would you typically put in your TFSA? any examples>

    Cheers
    D

  5. Ric says:

    Hello Derek

    I have a large amount of money to invest. 500K I want to spread the risk around so that if one stock takes a noser, the loss will not amount to much. What would you suggest on how many stocks would be in my list or about how much % for each typical stock. These would be spread into RRSP accounts TFSA accounts and investing account.I have heard of between 2.5% to 5%. that amounts to 25 to 40 stocks. What do you think?

  6. I prefer to put my savings into a TFSA rather than an RRSP. I like that I have the freedom to move my money if I ever need to. Also I like to save any tax I can because living in Canada we pay a lot of taxes.

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