Thursday, February 14, 2013

Pre-authorized RRSP contributions pay off large in the long run

The RRSP contributions deadline is coming up fast.  And while you may have every good intention of matching or increasing your contribution from last year – it can be difficult and stressful to come up with a significant amount of cash in short order.  Here’s a better plan for next year: a Pre-Authorized Contribution (PAC) program is a great strategy for getting the maximum amount of money into your RRSP eligible investments.

When you PAC, you are simply setting up a regular payment plan – usually an automatic withdrawal from your bank account -- in an amount you can afford.  Your investment starts growing right away, meaning it will likely enjoy more growth than if you wait until the end of the year.  Plus, you may benefit from the magic of compounding returns which can produce a larger nest egg than contributing a lump-sum at the RRSP deadline.

A regular PAC becomes part of your budget as a monthly cash outflow that you probably won’t miss and removes the temptation to spend those available dollars for personal consumption.  When markets decline, automatic contributions allow you to purchase more mutual fund shares or units, resulting in a lower average cost over the long term.

Here’s an example of the power of PAC-ing:
  • You set up a regular investment plan to invest an amount you can afford – say, $250 into your RRSP eligible investments on the first of every month.
  • At a compound annual return of 6.5%, you’ll have $278,000 of pre-tax assets after 30 years.*
  • If you wait until the end of each year and invest a lump sum of $3,000 into your RRSP eligible investments (presuming you can up with that large chunk of cash on short notice) you’ll have only $259,100 of pre-tax assets after 30 years.
  • By PAC-ing each month, you could potentially add $18,900 to your retirement fund – and it doesn’t cost you an extra penny!
  • In addition to the extra long-term tax-deferred appreciation, your contributions also deliver a nice tax benefit for the current tax year.
PAC-ing removes the stress of finding scarce dollars as the RRSP deadline looms and enhances your retirement income opportunities.  It’s a good investment strategy and there are many others.  Your professional advisor can help you PAC up all your life goals in one sound financial plan.

*The rate of return is used only to illustrate the effects of the compound growth rate and is not intended to reflect future values or returns on investment.

Monday, February 4, 2013

Smart strategies for top-up RRSP loans

If you’re like most Canadians, your RRSP eligible investments will likely be a vital source of retirement income.  However, like most Canadians, you’re probably not making the most of your contribution room. According to Statistics Canada, in 2010, almost 93% of taxfilers were eligible to contribute to RRSP eligible investments but only 26% actually made contributions, adding up to $33.9 billion in total contributions – but representing only 5.1% of the total room available.*

If you’re having trouble coming up with enough money to fill your available RRSP eligible investments contribution room this year or if you’ve got unused room from previous years, an RRSP loan may be a smart strategy.

RRSP eligible investments can provide solid tax savings along with tax-deferred, compound growth so the short-term interest costs of an RRSP loan can be outweighed by the long-term benefits.  Here’s an example **:
  • You’re entitled to make a maximum contribution to your RRSP eligible investments of $10,000 for the 2012 tax year but you have only $5,000 of cash on hand. So you borrow the additional $5,000 (at 7% interest) and – here’s the important part – pay it back in a year.
  • If your marginal tax rate is 35%, your additional $5,000 contribution gets you an immediate tax refund of $1,750 and (at an annual return of 8%) your $5,000 top-up loan earns an additional $400 at an interest cost of $190 for the loan.
  • If you leave the additional $5,000 in your RRSP eligible investments for 25 years, that top-up contribution will grow to more than $34,000 (at an average rate of 8%).
The keys to the success of a top-up RRSP loan strategy include:
  • Get a low interest rate that does not eat up your potential tax savings and investment returns.
  • Repay the loan as quickly as possible – preferably one year but, in most circumstances, no longer than two years.
  • Use your RRSP-related tax return to pay down your loan.
  • Consider using the cashflow from a Pre-Authorized Contribution (PAC) program to fund your RRSP loan payments. Depending on the interest rates using PAC income can help you by, for example, avoiding cash crunches that might prevent loan payments.
An RRSP loan is not the right strategy for everyone.  Your professional advisor can help you make that decision as well as how to make the most of your investment savings for retirement.

* Statistics Canada, The Daily, Friday, December 2, 2011,
** The rate of return is used only to illustrate the effects of the compound growth rate and is not intended to reflect future values or returns on investment.
Borrowing to invest involves risk and may not be suitable in all situations. Speak to a professional Consultant to see if this strategy is suitable for you.