RRSP and tax season are filled with a weird kind of panic. While you SHOULD be worried if you’re not going to file your taxes on time, missing out on your RRSP contributions isn’t the end of the world – especially if you don’t have any money to contribute in the first place.
Banks and other investment companies want you to be feeling that pressure. They want you to rush in and sign up for an RRSP loan or other investment vehicle.
Let’s take a step back and ask the age-old question: Should I invest or pay off my debts?
The Argument For Paying Off Debts
Assuming you agree that debt is, in theory, something you should want to get out of, paying off that debt when you have some money is both philosophically and mathematically satisfying. Whatever you’re paying in interest charges turns into an automatic return on investment when you pay off debt.
What this means is that if you’re being charged 20% interest on a credit card, then paying off the balance is like getting a 20% return on your money. Put another way, if you invested that money somewhere else and earned 10%, you’d still be losing 10% overall because of the credit card interest.
From a philosophical angle, debt really does equal a type of slavery, and you will never really be free until you’re debt-free. There is something immensely satisfying about knowing that any dollar that comes in now contributes to building up your mountain rather than filling in a hole.
The Argument For Investing
Specifically, should you invest in your RRSP if you’re in debt? Let’s do some quick math.
Say you’re $10,000 in debt and have $10,000 to invest or pay that debt off with. If you’re in a 30% tax bracket and contribute that $10,000 to your RRSP, you’ll receive an additional $3,000 in your tax refund (approximately). You could then use that $3,000 to reduce your debt to $7,000. In total, you’d have $10,000 in your RRSP and $3,000 less in debt, for a total gain of $13,000. On the other hand, you’ll still be paying interest on the remaining $7,000, and you’ll have to keep worrying about it.
On the plus side that $10,000 gets to start earning interest now, and the first rule of compound interest is to start early.
What Are Your Priorities?
Ultimately you’ll have to decide what your priorities are. If you’re comfortable with the idea of debt and can service your payments, the long-term prospect of your RRSP investment might be appealing.
If, on the other hand, you want to be debt-free and just got caught up in RRSP-season fever, getting out of debt will never be a bad financial decision. Skip this year’s contributions, and know that next year you’ll be able to put that much more in, as nothing will be going towards debt or interest payments.