This question comes up every year around February as the RRSP selling season hits its peak. The suggested solution from the RRSP sellers is that you can do both: make your RRSP contribution, and then use the refund to pay down your mortgage. But this isn’t a compromise. They will have achieved their objective and received your RRSP funds. Their real message is make your RRSP contribution instead of paying down the mortgage, period.
But what’s missing is an all-important question: How much will you need in your RRSP to retire comfortably? Is it $100,000, $500,000, $1 million? Without answering that question you are like a runner entering a track and field race without knowing where the finish line is! Are you in a hundred-yard dash or a marathon? It obviously makes a huge difference to your strategy and yet most Canadians enter the RRSP race completely unprepared. They’ll either burn out early and come up short or possibly overshoot their goal.
Why waste your life scrimping, sacrificing and saving every penny to build a million dollar RRSP then realize too late that you really only needed $200,000? Why die with $800,000 in the bank?
The only way I know to determine how much money you’ll need in your RRSP is to begin tracking your finances as soon as possible. With detailed information about where all your money is going now, you are armed and ready to get your finances under control. The first step is to determine if you are spending more than you are earning. That’s a sure-fire recipe for disaster regardless of whether you follow the RRSP strategy or try to pay down debt instead.
Tracking also will allow you to spot the money leaks and plug them as well as project which expenses you won’t have after you retire. Think about no more children’s costs, no mortgage payments, no costs associated with work and of course you won’t be siphoning off any more money to try and save for retirement since you’ll already be there.
OK, now you’ve thought about how much you’ll need. The next key figure you’ll need to know is what rate of return to expect on your RRSP investments and that’s a big problem since nobody knows for sure, no matter how intelligent and informed they may be. The place to start is with the past. While it doesn’t predict the future, it’s the best way to get some idea of what to expect. The problem is that most of us have no idea what rate of return we have made in our RRSP. Why not? Because our investment company doesn’t tell us.
That is why I wrote a simple Microsoft Excel worksheet I call the Personal Rate of Return (PRR) Calculator that comes with my book: Smoke and Mirrors: Financial Myths That Will Ruin Your Retirement Dreams.
The Personal Rate of Return Calculator
All you need to do is enter the date and amounts you invested in your RRSP since it started. Tell Excel the current market value of all your RRSP accounts and use the Solver to find out your personal rate. Has it been 8%? 5%? 2%? Worse?
Don’t fool yourself. If it’s been 2%, projecting future growth at 8% is foolhardy.
The next thing to do is list all your personal debt and their interest rates. Perhaps a mortgage at 5%? A line of credit at 7%? Maybe a bit of credit card debt at 10%? Compare your RRSP return to the interest on your debt. The greater the difference, the further ahead you’ll be by paying down debt before continuing to play the RRSP game.
David Trahair is a Chartered Accountant who has been dealing with small businesses for over 20 years. His book Smoke and Mirrors: Financial Myths That Will Ruin Your Retirement Dreams is available at Indigo, Chapters and other fine bookstores. For more information about David’s books and services, check out www.smokeandmirrors.ca.