Canadian Personal Finance Blog

Archive for February, 2006

So this scenario is a little artificial, in how I calculate the payments over the year. I am assuming a single lump payment a year, and throwing your refund directly onto the mortgage principle. No one has a mortgage like this (ok maybe someone does, but I don’t know them), and typically if you are paying monthly or bi-weekly, a lump sum payment of $300 in the middle of the year, may actually be better (depending on how your interest is calculated and compounded). Just note the data here, and think about it:

So what does this tell us? Well if you put your money in your RRSP, and then take the refund you get, and put that on your mortgage, you should shorten your Mortgage by at least 1 year (on a 20 year mortgage), if not more.

Tomorrow, which is the BEST way to work with your RRSP? –C8j

So, if we now say, hey, this whole idea of putting money away for my retirement over the next 20 years, would even be better, if I took my refund and put it in my RRSP as well, let’s see what might happen with our RRSP. Note that since you are doing this, your RRSP refund gets bigger each year because you put more in your RRSP (clever eh):

So in Case 1 we had about $39000.00 put away in savings and RRSP, now we have $47,000 in RRSPs, not bad. So if you can, it would be good to take your Income Tax Refund and bash that back into your RRSP.

Interesting mathematical progression there, since your refund only increases up to $429.00 or so, far out.

Next what about Debt reduction here? –C8j

So this case is pretty simply. Our family has their $1000 per year extra going into an RRSP, and when they get the money back they put it in a savings account that pays 1% (yes this is not the best, but we need a baseline to start from).

So at the end of 20 years we have $33,000 in our RRSP and another $6600 in our savings account (and paying tax on the interest on the savings account too). This is not bad really, you now have almost $40,000.00 put away for retirement and a rainy day.

Monday, what if we use the refund wisely? –C8j

OK, so one of the questions I hear people talk about is that if I can scrounge up an extra $1000 a year, which should I do:

1. Pay down the mortgage (assuming you can make extra payments on your mortgage)
2. Put Money in the RRSP
3. Both

This is a good question, I think, and something I’d like to do in a bit of detail, so over the next couple of days, let’s crunch the numbers and show what this might look like.

So, let’s lay down the ground rules, assuming the following:
1) A 25 year mortgage with 20 years still remaining on it at 6.0%
2) A single income to the family of $84,000 per year (vanilla tax return as well, no fancy trusts)
3) An extra $1000 found somewhere each year
4) RRSP growth of 5% per year (very conservative)
5) Savings growth rate of 1%

We’ll crunch the numbers in the three scenarios and then figure out what might be the best course of action here.

This should be fun –C8j

So one of the tricks financial planners like to pull out of their hats (in Canada at least), if you are going to receive a refund, you use a short term LOAN to buy more RRSPs and thus MAX out your RRSP.

Example:
If I was going to get a refund of $1200 (yeh right), if I took out a loan for $1560.00 I could max out my RRSPs. This assumes I am taxed at a rate of 30%, and that I pay off the loan right away (and I have $1560.00 in RRSP room as well). You don’t understand still? Let’s do the math:

• I would be getting $1200, so I could simply get a loan for $1200 and buy RRSPs with that, BUT I would then get a $1560 refund, because of the extra RRSPs that I bought
• Remember if you buy $1200 worth of RRSPs, your marginal rate is 30%, you would get $360 back for buying the RRSPs.
• So, I should take a loan for $1560 or so, and I will get more than $1560 in refund back (not much more, but a little), which I can then PAY OFF THE LOAN (this is REALLY important guys, don’t leave the loan hanging around). This means you now have more money in your RRSPs! Cool eh?

The important things to remember is, if you were planning on using your refund to pay down your mortgage or some other debt, that is good too, don’t get convinced that the only good idea is to get a loan to max out your RRSPs! Pay off the darn loan if you get it as well! DON’T BORROW THE MONEY FROM YOUR CREDIT CARD (can I be more exact, don’t do it).

It’s an idea, but not the ONLY good idea at RRSP time –C8j