Before you start investing in any form you need to understand the type of accounts under which trading can be done. Remember terminologies may be different for different countries. Being a beginner you always want to play safe and may ask your banker that you want to trade using bank’s platform(there are better options than banks depending upon your trading volume and preferences which we will discuss in a separate article). There is generally a separate department within bank to help opening a trading account. Remember from previous discussions, this account can be a registered account which helps to save tax or comes with some benefits from government or simply a trading account to earn profit. Considering example of Canadian accounts there are following options:
RRSP (Retirement saving plan) or 401k
The money you deposit in this account from your income reduces the taxable income by that amount. If I deposit $10,000 from my taxable income of $50,000 my new taxable income will be $40,000. So you save tax and get return while filing tax return in end of the financial year. Different countries name the account type terminologies differently. Remember this money we normally keep for retirement as whenever you withdraw money from this account, it is taxed at that time. So people prefer withdrawing money from it when they retire s at that time they have low income. At the time of writing this article government has set an annual limit of 18% of earned income from previous financial year. To be certain, check your account on CRA(IRA or government income tax) website. I would personally prefer to open this as self-directed account so that I can invest this money in stocks, bonds, ETFs, GIC as I please. You may take service of advisors or financial institutions. The pension or retirement accounts in U.S is known as 401k and in Canada as RRSP.
RESP (Education saving plan) or 529
This is an investment options for Canadian parents to save money for their kids for their post secondary education. An equivalent in U.S is known as 529 plan but with different features. The money contributed by parents in this registered pool gets benefits from government to a maximum of $7200. Most of the banks and financial institutions will ask you to open this account with them as they invest your amount in mutual funds and take commission or management fee as usual. I personally prefer opening this as self-directed account and would buy ETFs or stocks myself. However you can choose to take help of advisors or financial institutions. The amount contributed to this account does not change your taxable income. Only your beneficiary i.e. the child can withdraw money for his or her education. Although it is taxable on withdrawing this money but as it is withdrawn for education and your child will hardly have any income at that time so tax may be negligible
TFSA (Tax Free Saving Account)
This is the benefit provided by the government which you must utilize but wisely. The money added to this account (check the maximum limit allowed with CRA) does not reduce your taxable income. Benefit is, when you withdraw the money from this account it is not taxed. So basically you can invest money added to this account into stocks, ETFs, Funds, Bonds, GICs and whatever benefit you get is all tax free. On the other hand if you use regular money from normal margin trading account you are subject to capital gain tax. Remember to use only the amount permissible otherwise you may have to pay for over-contribution. Also, withdrawing amount in the same year does not reduce your contribution bucket. It will reset in the following year.
**Track the amount permissible and contributed in registered accounts carefully
The accounts which give you benefits from government in terms of saving tax or child’s education or retirement were registered. There are other accounts like Margin account for which you pay capital gain tax (generally on 50% of the profit). If I may say in loose terms it is like a trading checkin account. Remember you cannot directly trade from regular bank accounts ! Banks would love to lure you for Registered accounts. Through these accounts they sell their Mutual funds which earns fee for them. Now, everyone wants to take benefits from government but everyone does not know trading. This is when we become naive and want an institution where we can have ‘kind of’ blind faith. Welcome bank.
In the next articles I will discuss about investments and suggestions as per my knowledge.
Author: Gagandeep Singh