I’m a contractor and need to put money aside for income tax. Where should I put it until I need to pay taxes (RRSP, TFSA, etc)?
As a contractor, or other self-employed individual, you’ll want to set aside around a third of your income to pay income tax. (Possibly more, if you’re making more than $100,000 per year.) If you’re unsure of how much money you’ll need to put aside to pay your income tax then you can get a rough estimate by putting your net income (money you make after business expenses) into this income tax calculator. It’ll give you an approximate amount you’ll end up paying in taxes.
Something to keep in mind is if you’re going to owe the Canada Revenue Agency (CRA) more than $3,000 (or $1,800 in Quebec) then you’re going to need to pay your income taxes in quarterly instalments. In other words, you’ll end up paying smaller amounts once every three months instead of one lump sum in April. Details on how quarterly instalments work are available on the CRA website.
Getting back to the question, let’s say you now know how much money you need to set aside to pay CRA from your business. Where do you put it? Into a registered retirement savings plan (RRSP), a tax free savings account (TFSA), stocks? There are two main points to consider here. The first is the time-line involved. When it comes to taxes you know that you’re going to need the money in less than a year. It could even be less than three months (if you’re paying in instalments). So wherever you’re putting the money will be short-term. You’re not saving up for a dream home or retirement here, you’re just setting aside money to pay your taxes later in the year. RRSPs and guaranteed investment contracts (GICs) are long-term plans.
The other factor to consider is you need to place the money somewhere safe and stable. It may be very enticing to buy an investment or speculate on the value of cryptocurrencies, but remember you really want to have all your money you set aside for taxes in your account when the bill comes due. The CRA will not look kindly upon you if you’ve lost your would-be-tax dollars on a bad stock.
Given these two constraints (short time-line and a necessity for low-risk) the option I feel makes the most sense is a high interest savings account (HISA). A HISA is basically just a savings account you can get from a bank or credit union with a higher than normal interest rate. This means the bank pays you a small amount each month. Usually the HISA will pay a low percentage each month on the money stored in your account. Meaning if you’ve put $10,000 into your account for safe keeping until tax time you’ll likely make in the range of $5 to $20 each month. It’s not much, but it’s better than nothing and a lot better than losing a chunk of your tax money in the stock market.
Something else you might like to consider is banks will usually allow you to make your HISA a part of a TFSA. That’s a lot of alphabet soup so I’ll untangle it a bit. A high interest savings account makes you a small amount of money each month, a earning a small percentage of the cash in your account. This money you make from the interest is taxable income in most circumstances.
A tax free savings account is an umbrella term for various products where you can put money (usually investments) and not get taxed on the income you make. It’s possible to make your savings account a part of your tax free savings account. This means you won’t pay taxes on the interest you generate in the savings account each month.
My suggestion is to talk to your bank about opening a tax free savings account portfolio that will include a high interest savings account.
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