RRSP Season: Plan ahead

It’s RRSP season and many Canadians are scrambling to make their RRSP contributions.

RRSP season begins January 1 of each year and lasts for the first 60 days of the year. During this period, one is able to make RRSP contributions to retroactively reduce the previous year’s income, thereby reducing their tax bill and hopefully producing a tax refund.

RRSP season is a great tool to have, but shouldn’t be the only way RRSP contributions are made.

Many Canadians don’t make regular monthly contributions to their RRSP throughout the year and are left scrambling in the first 60 days of the next year to make a large lump-sum RRSP contribution. For the average Canadian, it may be tough to come up with a large lump-sum payment right after the holidays. This often leads to RRSP loans, borrowing off lines of credit to invest or no RRSP contribution made at all.

Borrowing to make an RRSP contribution isn’t always a good financial choice. First, interest on an RRSP loan or line of credit is not tax deductible. Also, the investment return in the RRSP should be greater than or equal to the interest being charged on the borrowed money to justify the cost of borrowing. If an RRSP is fully invested, the investor is subject to investment volatility and market risk. If the RRSP investments drop in value or fail to earn a return greater than the interest rate, one could end up paying more in interest than what is earned on investments for the year.

On the flip side, if an RRSP is held entirely in cash or cash equivalents with no investment risk, the investor will earn far less interest on the RRSP products than the interest charged on the borrowed money.

Lastly, if investors don’t receive a large enough tax refund to pay down the RRSP loan, or they lack the discipline to put the refund on the loan, an investor may end up paying interest for some time after the contribution, eating up additional cash flow that could be going to savings in the short run.

Smaller, regular contributions to the RRSP throughout the year will give investors the same tax reduction they seek but won’t leave them scrambling to come up with large sums of money in a short period of time.

Benefits to regular monthly contributions

1. No need to panic or borrow money to make lump-sum RRSP contributions
2. Investment returns are tax sheltered for longer.
3. Savings becomes a priority throughout the year since contributions are taken right off of pay

Having the ability to retroactively contribute to your RRSP can still be helpful to many, especially those who may be expecting a higher tax bill than normal in the previous year or for those with unconventional cash flow.