Apart from cold weather, February is a special month in Canada, it's RRSP season. It's a potential bonanza for financial institutions and financial sales people trying to prod folks to beat the contribution deadline for tax year 2010, March 1, 2011.
What is an RRSP? A Registered Retirement Savings Plan is a savings plan registered with Canada Revenue Agency. Contributions are tax exempt; so too, is income while the funds remain in the plan. Generally, you must pay tax on withdrawals from the plan. Many folks misconstrue today's potential tax break and allow sales people to convince them that they need an RRSP now.
Though not the popular view, an RRSP is merely one part of retirement planning. It must fit your overall retirement goals and plans. Before you decide to buy RRSP's, it is essential you understand these points:
- An RRSP is merely tax deferral. Taxes you "save" are today's value of taxes you will pay later – think about this.
- If you don't buy an RRSP this year, that's not a problem, your entitlement rolls forward when you might be at a higher tax rate.
- Don't decide to buy based on pressure, overt or covert, from anyone – even if they are your church brothers or sisters!
- Repay all debts, including your mortgage, before buying RRSP's. Exception: if your employer matches your contribution, maximize your contribution. Invest those funds in money market funds to safeguard capital. When contributions vest, examine tax effects of withdrawals; if favorable, pay down your mortgage.
- Learn about Tax Free Savings Accounts (TFSA's) – unlike an RRSP, TFSA contributions' aren't tax-deductible. But income earned is tax-exempt. So too, are withdrawals.
Here is a simple procedure that could help you evaluate your RRSP decision, and help fend off aggressive financial advisors who try to get you to buy (usually by borrowing) RRSP's … and boost their sales!
- I repeat, before you decide to buy RRSP's, review your retirement goals and plan, specifically, proposed timing of retirement, estimated value of other pension plans, projected net worth, and size of retirement budget gap. Identifying this gap is essential because this is what you should be trying to fill with your RRSP.
- If you do not have goals and plans I suggest you set some now – including a plan to become debt free, before you start your RRSP contribution.
- Your age and retirement timing should influence how you invest funds – the closer to retirement, the more secure the investment medium.
- If you are in debt, you need to understand the before tax cost of each debt compared to the potential income from investing. Removing debt is a guaranteed interest expenses' reduction. Repaying $ 10,000 debt with 30% before tax cost would reduce interest costs by $ 3,000 in one year. Even at a lower interest cost, consider debt repayment over investing. Remember too, the emotional and family cost of carrying debt.
- Do not borrow to contribute: If you need to borrow, probably you will not have funds to repay the loan amount. Your tax refund will be less than the amount you borrowed to contribute to your RRSP. And you don't know the future (James 4: 13-16)
- Despite pressure from media and salespeople, don't make your RRSP decision based solely on the tax benefit.
Should you repay your mortgage before starting an RRSP? Subject to available employer matching contributions I mentioned earlier, before any investing, I suggest you repay all interest bearing debt, and start saving to buy big-ticket items. Remember, repaying loans reduces interest expenses!
Seek help from an independent financial advisor before deciding on a path.
Copyright (c) 2011, Michel A. Bell