The other one

If you know everything, like most people who comment on this blog, don’t read this. Go watch BNN and listen to some wag in a bowtie lie to you.

Now, for normal folks, it’s time for a simple reminder. The difference between registered and non-registered accounts, and why you need both. Way too many of us believe the only two kinds of investments are RRSPs and TFSAs and, second, that investing outside those things results in a big tax bill. Let’s clear this up.

‘Registered’ accounts are just that. Registered with the government. Recorded. Controlled. Monitored. Contained. Reported. The amount you’re able to contribute is regulated by government decree, as are the kinds of investments which can be held inside. When you remove funds from an RRSP, they’re subject to tax. This is not the case with a TFSA, but contributions don’t save you tax, either. Both have their advantages – spelled out here in nauseating, teeth-splintering detail – but they’re also subject to politically-motivated change. (It’s an open question if Ottawa will eventually declare that the income from six-figure TFSAs will reduce CPP or OAS in retirement, for example.)

Of course, money earned inside a registered account is tax-free. This is the main motivator for most people. Returns on a non-registered account (sometimes called a ‘cash’ account – misleadingly) are taxable, but there’s nothing to pay when you draw income from them, and several ways to cut the bill to Ottawa. There’s no limit to how much you can stash in a non-reg portfolio. Also, a joint-non-registered account with your squeeze offers some solid advantages over a TFSA or RRSP. (To make this happens, you must trust your partner, which is apparently an issue. Many people would rather share fluids than finances.)

When partners have a joint non-reg account that they both fund, income-splitting is possible. Half the returns may be attributed to each partner, so if one’s in a lower tax bracket, you save. Also a joint account is legally the property of both partners. Thus, if one gets run over by a crazed, stoned Uber driver the funds are immediately the property of the other. Not so with a registered account since time’s required for the transfer of the assets. In a crisis, nobody needs that extra level of grief.

(Note as well that a joint non-registered account can slice taxes when considering an estate. If an aging parent opens one with a child, for example, the assets it contains become the property of the offspring when mom passes. No tax. No delay. No probate.)

What about the tax on non-reg investment income?

For most people, it’s a non-event. The bulk of gains will be in the form of dividends or capital gains, and both come with special features that drive lefties nuts. The dividend tax credit ensures less sting than when collecting interest. In fact people in the top bracket would hand over 50% of the interest earned, but just 29% of dividend income. Sweet. And it’s an even better deal with capital gains. (A capital gain is simply another term for ‘profit.’ When you buy something and it rises in value, that’s a capital gain.)

Capital gains not cashed in remain untaxed. If you do harvest the gain, half is tax-free with the rest taxed at your personal rate. So on a $50,000 cap gain the maximum anyone would pay (income over $250,000) would be $12,500, or 25%. For most people that rate is about half – meaning they keep 85% of the profit. How is that not a good deal?

By the way, when you hold things which increase in value or pay dividends in a registered account, these tax breaks may be lost. All withdrawals from an RSP, for example, are fully taxed as income in the year taken. (TFSA withdrawals are not added to income. Yet.)

So in retirement you can live off an RRSP but every withdrawal is subject to withholding tax. If you happen to also have a corporate pension, this could push you into a higher tax bracket. Remember that at age 71 you’ll be forced to start cashing in retirement plans (when they convert to a RRIF) and adding it to taxable income. Plus, the government could legislate the annual distribution (and the tax load) be increased at any time. It’s a risk that having a non-reg retirement fund avoids.

How do you start such an account?

Not at the bank, unless you hook up with an ‘advisor’ associated with the branch who would love to mummify you in mutual funds. Better that you use the bank’s discount brokerage division, or engage a fee-based advisor to put things together. The best assets for most are ETFs – exchange-traded funds – which don’t carry ridiculous fees and reflect the value of a basket of securities (equities, bonds, real estate trusts etc.) which they are based on.

The best structure for a couple? Two RRSPs, two TFSAs, one joint non-reg, a prenup and a pup.