Young Canadians are lucky to have both the Tax-Free Savings Account (TFSA) and the Registered Retirement Savings Plan (RRSP) to help tax efficiently build wealth.
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The TFSA and RRSP provide tax-efficient compounding, but in different ways
The TFSA is completely tax-free. No income earned in the account is liable for tax, nor is any withdrawal from the account.
The RRSP is effectively tax-free as well. However, it is a little more complicated. You get a tax deduction when you contribute to the RRSP. Inside the account any income earned is tax-free.
However, when you withdraw, your withdrawal is treated like income at your highest marginal tax rate. When you combine the tax deduction and the future tax liability, you end up close to tax-free; it just is a little bit more complicated.
You just have to plan a little bit more when you are using the RRSP. You want to withdraw in retirement when your income and tax rate are less to fully maximize the benefit.
Your 20s is the perfect time to start thinking about investing in a TFSA or RRSP
A perfect time to start thinking about using these accounts is in your 20s and 30s. You have decades to invest and grow your wealth. By investing tax-free, you can increase your annual investment income by as much as 20% (because you pay no tax).
Given its flexibility, the TFSA account is by far more attractive to young Canadians in their 20s. The average fair market value for Canadians between 25-29 is $13,149. That is not a bad start. It shows that young adults are thinking about building a nest egg and they are doing it tax-free.
The RRSP is likely less appealing to 25-year-old Canadians. They are still reaching peak income years, so the tax deduction benefit is less helpful during this time. That is likely why Canadians under the age of 35 only have an average RRSP balance of approximately $15,000.
Even though the RRSP might not be the right fit right now, it is a useful tax deduction tool for when you are hitting peak income years. The point is both the TFSA and the RRSP will be helpful on your wealth journey.
Pick smart stocks like WSP for your registered accounts
Picking wise investments is another important element to building wealth. In both these registered accounts, you want stocks that can compound solid returns over long periods of time.
WSP Global (TSX: WSP) is a perfect stock for a registered account. Even though its stock is down in 12% this year, it has a great long-term record of returns. In fact, over the past 10 years, this stock is up 478% (a 20% compounded annual growth rate).
WSP has grown to become one of the largest engineering and advisory firms in the world. Smart acquisitions have been key to expand its area of expertise and geographic footprint. Today, it has substantial operations on almost every continent.
WSP benefits from favourable long-term tailwinds like electrification, climate change, urbanization, infrastructure renewal, and data centre/artificial intelligence build out.
All these trends require massive investments that require engineering, planning, construction implementation, and management. As a multi-faceted leader, it can take greater share of these projects over time.
The Foolish takeaway
Stocks like WSP are perfect additions for TFSA or an RRSP. They have a great track record of returns and have strong prospects for the future. By combining wise tax planning and smart investing, you can see your wealth drastically grow over long periods of time.
