How should a 24-year-old invest now to minimize taxes in the future?

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Q. I’m 24 years old and have a dilemma. I have made the maximum contributions to my Tax-Free Savings Account (TFSA) every year, and now I’m wondering what money moves I should make next. By that, I mean what is the best investment route for me at this stage of my life so that I pay the least amount of taxes on my future investments?

As I see it, my two options are either to start an RRSP or, to start a non-registered investment account. I mostly like to invest in exchange-traded funds (ETFs) that offer both dividends and capital gains. Let me say that I study and work in the financial industry, and I am aware of the tax benefits of the RRSP but I do have a couple of concerns with it as a savings vehicle. First, your money is generally stuck in the RRSP until retirement—unless you are willing to pay high withdrawal fees. (I like to know that my money is accessible in some manner.) And, second, the RRSP is simply a tax deferment vehicle until age 71. Once the money is withdrawn, depending on your tax bracket, tax will be due.

In looking at non-registered investment accounts, I know that 50% of capital gains are taxed at your marginal tax rate when the investments are sold—but I’ll get access to my funds when I need them without the large tax implications of RRSPs.

I now earn about $50,000 annually (not including bonus), so opening an RRSP isn’t a huge benefit for me. However, I would like to purchase a property in three to five years and the option to borrow from my own RRSP* through the Home Buyers’ Plan (HBP) is somewhat appealing to me.

So I’m having a difficult time deciding what to do going forward. Should I start a non-registered investment account now, then open an RRSP in three to five years? Or, should the RRSP become my sole focus once my income is greater? And what would become of my non-registered investment account once I switch to an RRSP?
–Abe

A. Congratulations, Abe. This is an awesome dilemma that many young people—and even older individuals—wish they had.

You should continue to make maximum annual contributions to the TFSA* going forward since it’s one of the most flexible and versatile registered savings plans available. As you know, the TFSA allows you to set aside money in eligible investments and you can watch those savings grow tax-free. Interest, dividends and capital gains earned inside a TFSA are tax-free for life. You can make withdrawals at any time and all withdrawals are tax-free. It doesn’t get much better than that.

In regards to your other savings and investing options, I recommend you contribute simultaneously to both the RRSP and the non-registered investment account since these two accounts serve very different purposes. While the RRSP* is a true retirement account, the non-registered account is much more flexible since the money can be used to provide for several different financial goals, including a down payment on a home, retirement savings or lifestyle expenditures as they come up. Please note that while the RRSP can give you access to the Home Buyers’ Plan, I—unlike many other advisors—don’t recommend raiding the RRSP for this purpose, as years of growth are lost when the money is withdrawn early. Good investment returns inside the RRSP—especially from early contributions—will pay off nicely in retirement.

You can build your savings for a home down payment in the non-registered account, and as your income increases, so will your savings. If needed, money from the TFSA* can also be used for this purpose without the restrictions an RRSP Home Buyers’ Plan will entail.

One key thing to keep in mind to minimize taxes is that it’s not necessary to use the RRSP deduction in the same year you make the RRSP contribution. Consider claiming the deduction in a future year, preferably when your salary has increased. At that point in time, you have the benefit of a more meaningful tax deduction and refund. You are only 24 years old now Abe, and the likelihood of your income increasing in the future is great.

Using this strategy means the investments inside your RRSP will grow on a tax-deferred basis and give you 40-plus years of compounding. With a good investment portfolio mix that’s slightly aggressive given your age—perhaps 70% to 80% equities and 20% to 30% fixed income—your long-term returns should be very good.

Abe, check your employee benefits closely and see if you are a member of an employer pension plan, or will soon be. If you are a member now, this participation reduces the amounts you can contribute to your own RRSP. Check your CRA notice of assessment each year to verify the RRSP contribution room you have available to you. Your tax accountant can then help you decide what the appropriate RRSP* contribution should be for you’re having trouble deciding on your own.

If you have enough extra savings during the year, contributions to a non-registered investment account would be prudent. I recommend you consider using such an account for both your short-term and long-term investing. This type of account offers a lot of flexibility with consistent liquidity, as well as tax advantages if you chose to hold stocks or exchange-traded funds (ETFs) in them. Remember, stock dividends are taxed much more favourably than interest income, as are capital gains from the sale of stocks that have appreciated in value when it comes time to sell.

Abe, it looks like you also have an online trading account for your TFSA and I suggest you open similar accounts for your RRSP* as well as your non-registered investment account—all within the same financial institution for ease of money transfers, trades and the ability to get a complete picture of your finances at a glance from a single place. It will just make your financial life easier going forward.

Finally, you didn’t mention any debts. Keep in mind that debt repayment is also one of the best investments you can make, and if you have any personal debt, you may want to pay that off before you consider making any more investments.

Heather Franklin is a fee-for-service certified financial planner in Toronto.

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