Money talks: alphabet soup
by Arnold Machel, CFP®
“That is why it was called Babel—because there the Lord confused the language of the whole world.”
– Gen 11:9 (NIV)
It seems like every few years the government adds another type of account that an individual can deposit moneys into. Just take a look at your savings or investment statements and you’ll likely see some of the following types… RRSP, SRSP, RRIF, SRIF, LIRRIF, LIRA, LIF, TFSA, RESP (IND), RESP (FAM), RDSP, TFSA, OPEN, US$ OPEN, CASH, DPSP.
It can be overwhelming to try to figure out which type one should use and for what purpose. Each one has a unique set of rules around deposits, withdrawals, taxation and treatment on death. To make matters worse, some account types may be used for a variety of purposes; sometimes they may even be used for something other than their created purpose.
Broadly speaking (and somewhat over-simplifying), account types can be broken into three main categories…
Accumulation accounts: examples include RRSPs, TFSAs, and DPSPs
Withdrawal or de-accumulation accounts: examples are RRIFs and Locked In Retirement Accounts (LIRAs)
Specialty accounts: eg. RESPs, RDSPs.
While some account types could be considered to fit into more than one category (for example a TFSA could fit into any of the three), the classic examples and the ones you’re likely most familiar with and the most common are: the RRSP (Registered Retirement Savings Plan) for accumulating, the RRIF (Registered Retirement Income Fund) for withdrawing and the RESP (Registered Retirement Education Fund) for saving for children’s education.
Over the course of the coming months, we’ll look at each type in-depth including who is eligible to use them, how they get treated while the annuitant (essentially the owner) is alive and what happens on death. We’ll look at their pros and cons relative to other types of plans and help you navigate the ‘alphabet soup’ of name types.
We’ll start today by looking at a basic ‘non-registered’ account. Sometimes you may also see these listed as a Cash or an Open account. They are all the same account type going by different names. There may be a currency designation (eg. US$); if so, then it’s in that currency. Otherwise it’s in Canadian dollars. Non-registered accounts may be used for accumulation, de-accumulation or even for a specialty purpose. Since the accounts aren’t registered, they don’t generate any special benefits and they may be used in any way one wishes.
Non-registered accounts are fully taxable. These accounts usually have income that falls into three types (interest, dividends and capital gains). Interest is taxed like regular income, the same as your salary. Capital gains and dividends are taxed preferentially. A regular savings and/or chequing account is a type of non-registered account, one that would pay interest only.
When you hold investments in an Open account the account itself has no effect on taxation. Rather, your return is taxable based on the type of return or income received. Capital gains are taxed at 50 percent of your normal tax bracket. Eligible dividends (pretty much all dividends from major corporations) are taxed in a much more complicated way, but here in BC, if your income is below $46,605, the tax on a dividend is actually a net negative tax. You get money back for every dollar of dividend earned. Yes – you read that right. Because the corporation paying the dividend already paid tax on that money considered to be at a rate higher than your marginal tax bracket, you get the difference.
Aside from the dividend break for individuals earning less than $46,605, Open accounts have few advantages, especially when compared against TFSA accounts. For that reason, we generally recommend that they only be used once your TFSA and/or RRSP room has been completely used up.
Non-registered (Open) accounts do not have the ability to have a beneficiary designation, so generally they will be subject to probate and taxes on the death of the owner. The main exception is when they are held jointly (with right of survivorship). Then they pass straight to the survivor without the need for probate, but income taxes will still need to be paid unless the survivor is a spouse.
Taxation and estate treatment of these accounts is the same as when one holds an asset or investment physically (eg. holding share certificates). Holding the asset in the account (if you can) just makes everything simpler.
The first account someone opens is almost always a non-registered chequing/savings account. As one’s income and assets grow, it can be exceedingly advantageous to open other types of accounts. For example, it just doesn’t make sense to sit on cash in a chequing or non-registered savings account for any length of time if you have room to even temporarily shelter it from taxes using a TFSA.
As soon as you notice a bit of money accumulating, talk to your bank or professional advisor about what makes sense for you.
Arnold Machel, CFP® lives, works and worships in the White Rock/South Surrey area. He attends Gracepoint Community Church where he serves on the Leadership Team. He is a Certified Financial Planner with IPC Investment Corporation and Visionvest Financial Planning & Services. Questions and comments can be directed to him at firstname.lastname@example.org or through his website at www.visionvest.ca. Please note that all comments are of a general nature and should not be relied upon as individual advice. The views and opinions expressed in this commentary may not necessarily reflect those of IPC Investment Corporation. While every attempt is made to ensure accuracy, facts and figures are not guaranteed.