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RRSP Strategies

ImageThis applies to you if you are investing in an RRSP or have plans to each year. I was comparing the relative costs of contributing monthly into a plan or using an RRSP loan during RRSP season (January - February).

I know of a lot of people who usually contribute into their RRSP during the first two months of the year. This time is known as RRSP season, and is marked by extensive advertising by banks and financial companies who are selling their various investments. It is the last chance you have to add to your RRSP and get credit for the previous year. It is when you are the most vulnerable, since you have left things to the last minute. It is kind of like the snacks they put right next to the checkout in a supermarket.

Most financial institutions offer what they call an RRSP loan, which is a reasonably low interest one year loan so that you have the money to invest in your RRSP. It is fairly safe, since the money never leaves the building. You get caught up, and you have a year to pay it off before next year comes around.

The way I see it there are two flaws to this way of investing in an RRSP:

  1. You are paying into the system a year after the fact, so you lose out on a whole year of interest earned (and all interest that extra money makes over time)

  2. You are paying interest on repayments to your RRSP loan, instead of just contributing monthly.

Take a look at the following calculations: (click on the image to see the full sheet)

RRSP Calculation

For the calculations I tried RRSP contributions of $200 per month with 4% interest on investments and 6% interest paid on the RRSP loan.

In the first year, if you wait until the year end and invest an equivalent amount of $2,400, you missed out on $44.49 of interest.

In the second year, you are paying back the RRSP loan, including $78.71 of interest. Once you get into this pattern, you have no available money to contribute to your RRSP and you have to take out another RRSP loan the following year. It is a hard habit to break.

The additional cost adds up to $123.21 per year, which is more than half a month's contribution that you lose. Of course the financial institutions are the winners, which is why I like to own bank stocks.

So my recommendation is to pick an amount you can afford to pay each month and pay that into the RRSP monthly. Do not borrow an RRSP loan during RRSP season. During that time, you can watch all the TV ads and see your friends scramble to get RRSP loans, and smile to yourself.

An excel file of the calculations is found here

Pat

 
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