David Trahair: Because during what I call your "Spending Years" when you are paying for the house, cars, clothing, feeding and educating the kids, there simply isn't any money left to save for many people. I realize everyone is different and not all have kids but for the many that do, the only way they can make an RRSP contribution is to borrow to do it. In other words, if you have any debt whatsoever and you make an RRSP contribution you are effectively borrowing to do it at the highest rate on your debt because your alternative was to pay down the debt you already have. Even if you use your RRSP tax refund to pay down the debt - you are borrowing the net amount of the RRSP contribution. Being in debt means compounding is working against you - not for you.
This is why it makes sense to me to focus on paying off all debt including the house mortgage before investing in RRSPs. For most people that will be age 50 or later. That is not going to be easy. But that's the point - getting your finances under control and retiring well is not going to be easy and never was. This will take discipline and sacrifice.
But after you are debt-free, imagine how much money would be available to invest in RRSPs then? For many people their mortgage payments alone could be thousands of dollars a month. Your RRSP room will also have carried forward so you could start making large RRSP contributions and then could afford to reinvest the RRSP refunds. You would also (probably) be in your highest earning years and therefore highest tax bracket for maximum refunds.
I call this the "Tax Turbo-Charged RRSP strategy" in the book.
Online commenter Modiano: What do you think will be the interest rate for 5-year GICs bought this year? Do you think the high returns will continue?
David Trahair: According to Fiscal Agents, a deposit broker based in Oakville, you can currently get a 5-yr GIC with a CDIC-insured financial institution (Manulife I believe) making 3.2% a year. This is with interest rates at historical lows. I wish I could predict the future, but they can't go that much lower. Some people are predicting gradually rising rates as the government tries to slow inflation (if it becomes a concern).
I am no economist, but it seems unlikely that interest rates are going to rise quickly given the massive amount of government debt as well as consumer debt that exists today. I wouldn't bet on GIC rates rising that much very soon. Better to be conservative when making assumptions about GIC rates going forward.
James P: I'm a 28-year-old professional, and joined the workforce full-time last year after spending most of my twenties in school. I have few expenses - I am single, and have no dependents - and make enough money to put a few hundred dollars aside every month, and have about 5000 in my RRSP right now. But I am not sure where to put my savings, and I wonder if RRSPs are the right choice anyway. I am reluctant to invest in mutual funds because I think I may need money in a few to put a down payment on a home. Do you think GICs would be a good choice for me?
David Trahair: Good question. I think it makes sense in your case to look at a Tax Free Savings Account (TFSA). The interest on your GIC will not be taxed and you can put up to $5,000 in for 2009 and another $5,000 in 2010.
I agree with you regarding equity mutual funds - they may work out but the risk of losing and therefore having your home purchase delayed is too much of a risk as far as I'm concerned.
Follow us on Twitter: