As the year 2013 draws to a close, no doubt that many people are wondering whether or not to lump or not to lump your RRSP payments this year. I’m sure that’s much more important than making your Christmas list and checking it twice, to see who’s been naughty or nice.
The 2013 RRSP contribution deadline for 2013 is March 1, 2014. Typically during these times, financial advisors are very busy because everyone is busy contributing what they can to their RRSP in order to reap the tax deduction come tax season.
As an individual who does both lump sum payments and regular small payments, I would like to share a few reasons why not contributing to your RRSP payments in a lump sum might be a better idea.
The Globe and Mail (partnering with Investment Education Fund) recommends that contributing smaller amounts more often is a better idea than lump sum payments. If you contribute to your 2013 RRSP on March 1, 2014, you have potentially missed out on almost 15 months of tax sheltered investment growth. If you had started on January 1, 2013 (perhaps the financial news years resolutions were really motivating this year) and contributed smaller amounts over time, this gives more opportunity for compound growth to occur.
Dollar Cost Averaging
Depending on the investment you have in your RRSP, contributing regularly to your RRSP beats lump sum payments because of dollar cost averaging. Dollar cost averaging basically lets you avoid timing the stock market (because we all know how successful timing the stock market really is) by purchasing investments at the same time each month. Therefore, over time, you will have a more balanced investment, instead of purchasing at a time when investments might be overpriced. It’s like buying an investment whether it is on “sale” or “not” because we never know how much of a “sale” investments really can be.
Regular Contributions Don’t Hurt as Much
Another reason to go with regular RRSP payments is because well… regular small payments don’t hurt as much. If you take it out regularly (for example, with a pre-authorized deduction from your bank account), you won’t even realize that the money isn’t there.
Compare this to a lump sum payment, where you have difficulty coming up with $22,000+ (which is the maximum allowable RRSP room for 2012), especially in February/March. Why is it so difficult to come up with this exorbitant amount of money in the beginning of the year? Five words: holiday season credit card bills. Most people have a difficult time paying off the December credit card bill in January because holiday season presents and Boxing Day splurges are usually evident on these said credit card bills. Add into the mix the dreary and depressing February/March weather and you get a lack of motivation to save money and spend it on your retirement.
Avoiding the RRSP Loan
Finally, when you contribute regularly in small increments throughout the year, you will be more likely to avoid the RRSP loan. As we mentioned earlier, many people simply can’t come up with the large RRSP contribution amount at the beginning of the year and many individuals opt to take out an RRSP loan. Many banking financial advisors will also be trying to sell you that RRSP loan.
Although RRSP loans may be a good idea, especially if you are in a high income tax bracket, they may not be a good idea if you cannot pay off that loan within a year. Many people use the tax return to pay off the RRSP loan. Ideal situation is that an RRSP loan isn’t necessary, but if it means tax sheltered investment over time, then so be it!
One downside to taking out an RRSP loan is that the interest on the loan is not tax deductible. If you were taking out a loan to invest in a non-registered account, the interest would then be tax deductible. Another downside is that an RRSP loan is more debt. As a country already consumed in consumer and mortgage debt, the last thing we really need is more debt.
Bargainmoosers: Do you lump sum or not lump sum?
(banner image credit: 401 (K) 2013)