Although there’s lots of discussion about the best way to save for retirement, one thing is clear: If you’re going to use an RRSP, making the maximum contribution as early as you can is almost always the way to go.
Not that most people do. Instead, they scurry to the bank during the last few days of February — and that’s a mistake.
When you invest this way, you’re always playing catch up, effectively remaining one year behind in receiving those tax refunds, and subsequently getting a lower overall return on a lower RRSP balance.
That’s why contributing to your RRSP year-round makes so much sense. For starters, you aren't faced with the problem of coming up with a large lump sum right before the deadline. More importantly, regular contributions force you to save, to “pay yourself first” — something that most of us have a hard time doing.
Where Borrowing Can Make Sense
What do you do when the deadline for contributing (it’s March 2 this year) is near and you just don’t have the money? Well, you can go into debt. While perhaps a bit counterintuitive, this generally makes financial sense as long as the return on your investment is somewhere near the interest rate you're paying on the loan.
As a rule, if you can repay your RRSP loan within one year, borrowing can pay off. Your cost will be the interest you paid for one year. Your gain will be one year of tax-deferred growth, which should far outweigh the debt cost over the long haul.
Getting More Money Working Faster
Here’s another option for you to consider, which is often called the “gross-up” strategy. Although simplified a bit here, it works well, particularly if you find yourself in a higher tax bracket.
Suppose, for example, that you’re in the 40% tax bracket and you’re trying to put away $500 each month towards your RRSP. At the end of the year, you can expect to get a RRSP receipt for $6,000, which will trigger a $2,400 tax refund ($6,000×40%) — which is great. But it’s actually still a far cry from what you could do.
Instead, head to the bank at the beginning of the year and arrange to borrow $9,500 to fund your contribution – getting your receipt as quickly as possible. Most institutions offer short-term RRSP loans at prime or better. Online bank Tangerine, for instance, is currently offering a very attractive 1.5% promo rate.
Then, contact the Canada Revenue Agency and ask them for a confirmation letter allowing your employer to reduce your source deductions to reflect this RRSP contribution. You can do this by filling out the CRA’s Form T1213.
An Extra Year Of Tax-Free Growth
Depending on how quickly your employer reacts, this will translate into an extra $317 per month ($9,500 x 40% divided by 12) in your pay cheque to help make the payment on your loan, which is going to be close to $800 per month. $500 of that will come from you as it would have anyway and the remainder will come from the boost you’ll get in take-home pay each month.
This way, instead of steadily putting $6,000 into an RRSP over the course of a year, you’ll actually have $9,500 working for you right from the beginning. Once you get started, the result is an extra year of tax-free growth, without any significant out-of-pocket expense.
Keep in mind that a lower tax bracket will mean a smaller refund and therefore more money out of pocket. But, on the assumption that your future returns will eclipse your borrowing costs, it can still be a worthwhile exercise.