Different types of savings accounts
A standard HISA is a very safe and secure way to squirrel away some money and earn a small amount of interest in the meantime. For medium or long-term savings, Canadians should consider holding their HISA in one of two types of registered plans that will help mitigate the amount of tax you will owe on your interest earnings.
Tax-Free Savings Account
TFSAs allow you to invest up to $6,000 per year and not pay any taxes on the earnings. You are free to withdraw the money, tax-free, at any time. The savings plans available within a TSFA may have somewhat lower interest rates than some other HISAs, but could be a better choice after considering the tax savings.
Registered Retirement Savings Plan
RRSPs are a tax-deferred retirement savings plan that allows Canadians to defer paying taxes on their income until after retirement.
Canadians can defer paying taxes on up to $27,230 this year and instead hold that money in a savings account (or other types of investments, including stocks, bonds and ETFs) within an RRSP where earnings will accrue tax-free as well. When you withdraw the money to use for living expenses in retirement, it’s typically taxed at a lower rate, assuming your income in retirement is lower than when you made the original contribution.
Why do the interest rates on a savings account go up and down?
The interest rates on savings accounts fluctuate, sometimes on very short notice. In 2020, for example, there were several rapid changes—mostly on a downward trend. In that case, it’s not hard to understand why. The COVID-19 pandemic threw the world’s economies into disarray, and this was reflected in interest rates. The rates offered by savings accounts are controlled by the prime rate, which is linked to the Bank of Canada’s policy rate. In times of economic turmoil, the Bank of Canada might reduce its interest rate to stimulate the economy by making it more affordable for people to borrow money. This shift affects your interest rate. In general, the interest rates are high in a strong economy, and they are lower during downturns.
Reductions in the Bank of Canada policy rate might negatively affect your savings account, but they do have benefits. You’ll get a very attractive interest rate when taking on or refinancing a mortgage, for example. The same goes for personal loans. If you’re looking for a good savings rate and can plan to set aside your savings for a certain term, you might consider moving it to a GIC. GICs offer guaranteed interest rates for a given term so needn’t worry about fluctuation.
The rates for GIC, like with many investments, go up and down with the economic environment. Right now the GIC rates are very low, despite the fact that the money is locked in. So, look at GIC rates when deciding what to do with your money. Would you want to tie up your money for the minimal payoff.
Is having a savings account really necessary?
Even when the economy is strong, the interest rates on savings accounts tend to be in the low single digits. If you compare this to real estate or stock portfolio returns, you might wonder why you should hold a savings account at all. The thing to understand is that these aren’t comparable products. They’re apples and oranges, each used for different specific reasons.