Fundamentally, there are four avenues that the average Canadian may consider over their lifetime:
- Registered Retirement Savings Plan (RRSP)
- Registered Retirement Income Fund (RRIF)
- Tax Free Savings Account (TFSA)
- Non-Registered Investment Account (NRIA)
The first three account types are registered with taxation authorities and as such are accompanied by rules and regulations that must be followed to obtain specific taxation advantages or to avoid penalties for non-compliance.
The NRIA is not encumbered by the requirements of the registered accounts and about the only requirement is to ensure that the CRA receives full disclosure of income earned, capital gains or losses and administration fees that may be incurred throughout the calendar year.
Many taxpayers that have one or more of these investment vehicles relinquish management of such to institutional investors, not realizing that all these investments can be placed into a self-directed investment vehicle within their financial institution or investment firm.
ADVANTAGES OF SELF-DIRECTED INVESTMENTS
- Lower cost per trade. Most institutions will allow trades, buying and selling, for approximately $10.00 per trade transaction.
- Investors can make trades online quickly and efficiently without the need to contact your broker.
- Most self-directed trade sites provide information about the investment. Reports show important information that include, to mention a few areas:
- balance sheets, income statements, cash flow statements quarterly or year to date
- history of dividend payments
- high and low market value of the investment for not only the current but past years
- other investors’ analyses of the company and, in some situations. a rating of whether to buy, sell or hold the investment
- current news updates on the company
- The investor has control of the investment rather than leaving the decisions in the hands of an investment firm or another individual.
- The investor is not locked into specific investment vehicles such as Mutual Funds, Exchange Traded Funds, specific individual stocks, bonds or GICs that may be an institutional investor’s approach.
- Some financial institutions offer a “play” account wherein you can practice trading using their software to become accustomed to how the system works and also gain insight into how well the investments would have done if you had invested.
- Many financial institutions aid investors want to self-direct their investments.
DISADVANTAGES OF SELF-DIRECTED INVESTMENTS
- An unsophisticated investor may not have sufficient knowledge to determine the appropriate investment decisions considering factors such as their age, portfolio diversification and risk tolerance.
- Familiarity with the investments that are allowed and not allowed in registered investment vehicles is required.
- Investments in foreign jurisdictions may become problematic if foreign tax authorities require registration or reporting in their country.
- Investors may not be familiar with tax requirements.
- Record keeping is essential for non-registered investments as taxation authorities need to know the buy price, sale price, commissions, dividends, income, capital gains, capital losses and administrative cost. Some online brokerages may provide this reporting for their investors.
- A starting portfolio with low investment may not offer a return on investment comparable to an investment firm that can comingle smaller amounts to create a large investment portfolio.
- A minimum deposit amount may be required to open a self-directed account.
- Financial investors may charge an annual fee. These fees may be hidden in the RRSP or TFSA investment vehicles. These fees are not tax deductible but simply reduce the overall amount that is available for investment. Similarly, within an NRIA, the more that it costs to administer or complete trades, the less that is available for investment growth. Investment fees within an NRIA are tax deductible.
- The transfer of all four investment categories from a managed portfolio into a self-directed portfolio in kind is permissible. Many investments held in a managed portfolio can simply be transferred over to a self-directed account without the need to liquidate and repurchase. Some investments can only be held in a managed portfolio and accordingly would have to be liquidated. Generally, there are no tax implications of liquidating assets held in an RRSP or TFSA (as long as the funds are not withdrawn from the account). Naturally, you must stay within the confines of a financial institution. You may be charged an administration fee. Most online brokerages cover the fees for transferring your investments.
- Investors must determine if they want interest, dividend or capital gain growth in their investment. Unlike dividends and interest growth, the capital appreciation of a stock compared to its original cost does not necessarily result in an increase in cash, unless the stock is sold. Accordingly, if an investor chooses to hold a stock and its value subsequently decreases, that money is no longer available to invest.
- A capital loss within an registered vehicle is not tax deductible. It merely reduces the amount of the investment when the stock is sold.
- A capital loss on a NRIA under normal circumstances can only be used to offset capital gains, though these losses may be carried back or forward to other taxation years.
- There are limitations on investments that can be made in registered accounts. The CRA considers these investments to be qualified investments. Investors should be familiar with investments by visiting the CRA website and referring to the publication Income Tax Folio S3-F10-C1, Qualified Investments-RRSPs, RESPs, RRIFs, RDSPs and TFSAs.Failure to follow the rules and investing in non-qualified investments could result in a tax of 50% of the fair value of the investment at the time it was purchased or became non-qualified.
- An investor could choose a company for its dividend potential. However, if the market value drops below the original cost, the dividend income may not be sufficient to make up the capital loss.
- Investors must determine whether they are going to purchase and hold or actively trade. The CRA has been cracking down on TFSA abuses where investors have been allegedly running a trading business in these accounts.
- You can invest in debt obligations, mortgages, precious metals, warrants and options, securities on designated stock exchanges, money and deposits with Canadian banks, trust companies and credit unions (GICs). However, before making an investment outside designated stock exchanges or GICs, ensure you understand the requirements and restrictions.
- You cannot invest in digital currency.
Converting a managed investment vehicle to a self-directed vehicle is not for everyone. Those who are anxious about their ability to take on the responsibility for their retirement nest egg may not mind paying a management fee and thus are best to stay with a managed account. Others who feel confident in their investment prowess may determine that the risk of self-investing is more than offset by the potential increase in their portfolio value that they may realize by investing the administration fees they did not have to pay.
**This blog is for information only and not to be used as tax advice or planning without first seeking professional advice. Information is subject to change without notice.
***This article was originally published in Volume 32, Issue 5 of Business Matters in October 2018. BUSINESS MATTERS deals with a number of complex issues in a concise manner; it is recommended that accounting, legal or other appropriate professional advice should be sought before acting upon any of the information contained therein. Although every reasonable effort has been made to ensure the accuracy of the information contained in this letter, no individual or organization involved in either the preparation or distribution of this letter accepts any contractual, tortious, or any other form of liability for its contents or for any consequences arising from its use. BUSINESS MATTERS is prepared bimonthly by the Chartered Professional Accountants of Canada for the clients of its members. Richard Fulcher, CPA, CA – Author.