We have seen a lot of well-done TV and social media ads from major banks and investment companies lately all selling the same message; “sock away as much money as you can now so that you can enjoy that sailboat later!”
Sure, saving money is important. But, are you ignoring debt to do so? The banks and investment companies push “save money” and “take on debt” at the same time because they enjoy large profits on both ends.
But what should you really do? Sacrifice savings to pay down debt or do both? The answer like so many things in life is it depends.
Let’s Get Real About Debt
Before you decide which option you’re doing to take, contribute to RRSP or pay down debt, the first thing you should do is sit down and document all your debt. We know, that can be painful. But it is time to be honest with yourself.
What is your balance on each account, what is your monthly payment, and what interest rate are you paying?
RRSP Factors to Consider
There are two factors to consider about an RRSP contribution:
What realistic rate of return can I predict long-term?
What tax savings can I expect on my contribution?
For the rate of return, there are of course a number of variables such as your risk tolerance, the portfolio chosen, and the market performance in general.
A good range a financial planner would suggest is somewhere in the 4-8% range long term. Anything above that is probably unrealistic.
For tax savings, your personal tax bracket will determine most of this question. Take a look at your last return, or returns, and talk to your accountant on how a contribution will boost your return.
Comparing your Debt Versus Return
In many cases, the dilemma between these two is a no-brainer.
If you have $10,000 in credit card debt averaging an 18% interest rate, then contributing to an RRSP, regardless of your tax bracket and potential rate of return isn’t the right choice. When looking at the math, it makes way more sense to use this money to pay down debt.
Remember, only make between 4-8% return or pay 18% or more in interest? We see many clients who are religiously making an RRSP contribution while not making a dent in their credit card balance.
We’re not talking about stopping your RRSP contributions permanently. You want to sacrifice for a short time to pay down the bad debt before contributing back to your RRSP.
Good Debt versus Bad Debt
This brings up another point; what is bad debt? Bad debt is consumer debt; credit cards and car loans are your primary suspects.
Now, if you only have ‘good debt’, such as a mortgage a home equity line of credit, the decision to stop making an RRSP contribution becomes a bit trickier. However, we can probably make an educated guess and say you can still contribute.
However, if your interest rate is below 3%, and you are in a higher tax bracket, then you should consider professional advice from a financial planner or accountant as to what the best use of your money is.
But again, don’t just rely on just an opinion, ask to see the math!
Type of RRSP
One other factor to consider is whether your employer offers a group RRSP where they make matching contributions. If you contribute $10,000, and your employer contributes another $10,000, then this of course is another factor that needs to be considered. You could build your RRSP much quicker this one rather than making individual contributions.
One day we’ll get sick of saying “it depends.” Well, we’re already sick of it, but we have to—it has to make sense for you.
Look at your overall financial situation and list all the things we listed above plus everything we didn’t mention, like monthly bills and subscriptions. Once you have your picture, figuring out where your RRSP contribution will go will be pretty straightforward.
Get advice from the financial experts (like us, duh) and do your research. But, signing your money over to your bank for a last-minute RRSP contribution because you’d love to be on that sailboat later in life may not be your best move, despite how beautiful that sunset in the commercial looks!