RRSP contribution versus paying down debt

If you contribute to your RRSP, you’ll pay less taxTax A fee the government charges on income, property, and sales. The money goes to finance government programs and other costs.+ read full definition. But if you pay down debtDebt Money that you have borrowed. You must repay the loan, with interest, by a set date.+ read full definition, you’ll pay less interest. Which is better? There are many factors to consider, and it all depends on your personal and financial situation.

Start by doing the math

Use this calculator to help you compare the rate of return you’re getting from your RRSPRRSP See Registered Retirement Savings Plan.+ read full definition investments against the interest rateInterest rate A fee you pay to borrow money. Or, a fee you get to lend it. Often shown as an annual percentage rate, like 5%. Examples: If you get a loan, you pay interest. If you buy a GIC, the bank pays you interest. It uses your money until you need it back.+ read full definition you’re paying on your debt.

But it’s not as simple as going with the higher rate.

Get a clear picture of all the numbers involved

  1. What exactly does your debt cost you each month or year?
  2. Are there fees or penalties if you pay your debt off faster? Example: making extra mortgageMortgage A loan that you get to pay for a home or other property. Often the loan is for 20 years or more. You make a set number of payments for a set amount each year.+ read full definition payments.
  3. How do you plan to investInvest To use money for the purpose of making more money by making an investment. Often involves risk.+ read full definition the money in your RRSP? If you put money in safe investments that guarantee your return, your money will grow more slowly. If you choose investments that may grow faster like equitiesEquities Another word for investments in the stock market.+ read full definition, there is no guarantee what you will make. You may even lose money.
  4. What costs will you pay to invest?
  5. How much tax will you save if you contribute to your RRSP this year?

To help you with your decision, you may want to talk to a financial advisor. Learn more about how to manage debt.

Consider these 5 factors

1. Type of debt

The higher the interest rate on your debt, the more important it is to pay it down as quickly as possible. Example: credit card debt. But not all debts work the same. For example, mortgages are very different from credit cards.

2. Amount of debt

If you’re carrying a large amount of high-interest debt, you’ll be paying a lot in interest. Your priority will likely be to pay down this debt. If you owe a smaller amount, you may have more optionsOptions An investment that gives you the right to buy or sell it at a set price by a set date. The buy right is termed a “call” option, and the sell right is termed a “put” option. You buy options on a stock exchange.+ read full definition. You may decide to put a little money in your RRSP, a little toward paying down debt, and then use any tax refund to pay down the debt further.

3. Your age

The closer you are to retirement, the more worried you may be that you haven’t saved enough money to live comfortably. But if you have high-interest debt, you may still want to try and clear it before putting any more money into your RRSP. Most financial experts recommend going into retirement mortgage-free and debt-free.

4. Your tax bracket

If you’re currently in a higher tax bracket, it may be more important for you to reduce the tax you pay than for someone in a lower tax bracket. You may want to make an RRSP contribution instead of paying down your debt, despite the interest charges. But if you expect to be in a higher tax bracket in retirement, you may want to pay down the debt now.

5. Type of RRSP

There may be other benefits to your RRSP that you consider more of a priority than paying down debt. For example, if you have:

  • a group RRSP and you want to get matching contributions from your employer, or
  • a spousal RRSP and you want to build it up for income-splitting purposes in retirement.

Key point

It’s a complicated decision. Consider:

  1. Type of debt
  2. Amount of debt
  3. Your age
  4. Your tax bracketTax bracket The rate at which you pay tax, based on your income level.+ read full definition
  5. Type of RRSP
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