Find out why RRSPs, RRIFs and TFSAs are three of the tax-free investments we frequently recommend

Some investments let you earn income—including interest, dividends and capital gains—tax free.

Furthermore, tax shelters are legal investment vehicles that let investors pay less tax. While some are risky and should be avoided, others are great ways for Canadian investors to cut their tax bills. Below are three of these tax-free investment products for Canadian investors.

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What investors should know about Registered Retirement Savings Plans as an option for tax-free investments for their retirement

Registered Retirement Savings Plans, or RRSPs, are a form of tax-deferred savings plan. RRSP account contributions are tax deductible, and the investments grow tax-free. When you later begin withdrawing the funds from your RRSP, they are taxed as ordinary income. RRSPs are the best-known and most widely used tax shelters in Canada.

A spousal RRSP is one way to achieve equal retirement income. Suppose you are the higher-income spouse. You can make contributions to a spousal RRSP, and claim the tax deduction. Your contributions to the spousal RRSP will count toward your annual RRSP deduction limits.

Your spouse can still contribute their full deduction to their own separate RRSP. When the money is withdrawn from the spousal RRSP years later, it is taxed in the hands of your spouse. That’s an advantage if he or she will be in a lower tax bracket.

Tax free savings accounts let you earn investment income without the drawback of tax payments

The federal government first made the tax free savings account (TFSA) available to investors in January 2009. These accounts let you earn investment income—including interest, dividends and capital gains—tax free.

You can contribute a maximum of $5,500 to your TFSA in 2018 and each year after. However, if you have not contributed in the past, or did not meet maximum contributions in any given year, you can catch up on unused contributions. (Up to the $57,500 limit as of the 2018 calendar year, or $5,000 per year from 2009 to 2012, $5,500 per year from 2013 to 2014, $10,000 in 2015 and $5,500 in 2016, 2017 and 2018.)

Unlike registered retirement savings plans (RRSPs), contributions to TFSAs are not tax deductible. However, at the same time, withdrawals from a TFSA are not taxed.

Using tax-free investments wisely: How your tax-free savings account can complement your RRSP

Your TFSA can generally hold the same investments as an RRSP. This includes cash, mutual funds, publicly traded stocks, GICs and bonds.

As mentioned, contributions are not tax deductible, as they are with an RRSP. However, withdrawals from a TFSA are not taxed. This makes the TFSA a good vehicle for more short-term savings goals.

If funds are limited, you may need to choose between RRSP and TSFA contributions. RRSPs may be the better choice in years of high income, since RRSP contributions are deductible from your taxable income. In years of low or no income—such as when you’re in school, beginning your career or between jobs—TFSAs may be the better choice.

Investing in a TFSA in low income years will provide a real benefit in retirement. When you’re retired, you can draw down your TFSA first, then begin making taxable RRSP withdrawals.

Over the years, as the value of your TFSA increases, you could switch to a portfolio of conservative, mostly dividend-paying stocks spread out across most if not all of the five main economic sectors.

You will eventually want to roll your RRSP into a RRIF

You can convert your RRSP into a Registered Retirement Income Fund (RRIF) by the end of the calendar year in which you turn 71. RRIFs are used by those who don’t plan to cash out their RRSP as a lump sum when they retire, and prefer to extend their investment and take smaller withdrawals by converting to a RRIF. Registered Retirement Income Funds offer more flexibility and tax savings than annuities or a lump-sum withdrawal.

Converting to a RRIF is the best retirement investing option for most investors.

Like an RRSP, a RRIF can hold a range of investments. You don’t need to sell your RRSP holdings when you convert—you just transfer them to your RRIF.

When you hold a RRIF, you must withdraw a minimum each year and report that amount for tax purposes. (You may withdraw amounts above the minimum at any time.) Revenue Canada sets your minimum withdrawal for each year according to a schedule that starts at 5.28% of the RRIF’s year-end value at age 71, reaches 6.82% at age 80, and levels off at 20% at age 95.

What type of tax-free investment do you hold that hasn’t performed like you expected?

What is your preferred tax-free investment for retirement income? What do you like about it?