We are now February 1st and you have only a month left to contribute to your RRSP. But simply putting money aside in a RRSP account will only do so much. In fact, there are some basic strategies that could make your retirement portfolio much bigger. These strategies can be applied by anybody without much financial background of heavy calculation.
Reinvest your tax return into your RRSP
Many people do it already but I wanted to point the power of compound interest of this strategy. Let’s say that you make 75K a year and you are taxed at 40%. If you make a contribution of 5K per year for the next 25 years, your portfolio would worth $394,772 with an 8% return.
Over this period of time, you will receive $2,000 in tax return every year. If you invest this amount of money over 24 years (you get your tax return only after the 1st year of contribution). This would equal to another $144,211 in your portfolio for a total of $538,983 in today’s dollar.
In addition to that, you will also receive an addition tax return on that extra 2K contribution you are making after the first year. This tax return equal $800. You can invest this amount as well in your RRSP over the next 23 years in order to get an additional $52,611. at this point, your $125,000 overall contribution (5K * 25 years) would give you $591,595. So by investing your tax return from your RRSP contributions, you will get $196,823 more in your portfolio.
If you want to make the exact calculation I suggest you go on the Ernst & Young Tax Calculator to get your marginal tax rate. Then, you can use any investment calculators from bank’s website or even better, bring your numbers to your banker and make him do the math!
Take a deferred payment RRSP loan
We will keep the same numbers from our previous example in order to demonstrate the power of taking a deferred payment RRSP loan. In financial planning, they say that RRSP loans are good as long as you are able to pay them off within two years. An interesting technique is to calculate your tax return according to your RRSP contribution and to make a loan in that amount.
In order to not affect your cash flow, you can take a RRSP loan in January of 2K and defer your first payment in six months. Therefore, you will not have to make your first payment before you get your tax return. In addition to that, your tax return will be of $2,800 instead of $2000 because your overall contribution for the first year will be 7K compared to 5K without the RRSP loan.
In our calculation, this accelerates the additional investment by 1 year in term of contribution. Therefore, you would get a total of $610,365 in your RRSP account after 25 years. However, you would have to pay interest on your 6 months RRSP loan where you don’t make any payment until you get your tax return. At a 7% interest rate on 2K over 6 months, this represents $70 per year or $1,750 for the full 25 years. However, you find yourself richer of $17,020!
You can easily get your tax refund from Ernst & Young’s website or then again, make your banker does some maths to make you richer. After all, it’s his job!
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