RRSP Contribution vs. Paying Off a Debt

by Beth Winston

It can be hard to set smart goals for your limited income, especially if you have significant debts, such as a credit card balance or student loan. Deciding if a retirement contribution comes first or a payment to your debt should be a question of both financial strategy and math.

Employer Matching

The first question to ask yourself is if you can get employer matching in your RRSP account. Employer matching payments are in effect, free money, and you should not miss out on them. Make at least the lowest RRSP contribution that you can in order to attract the maximum employer match -- some are as good as 50 percent, and that’s a return you won’t see on any other investment.

Type of Debt

Next, consider what type of debt you are paying off. If it’s unsecured, such as a credit card debt where the interest rate is high or variable, this is a much higher priority than something like a student loan, where you have a low rate and tax-deductible interest payments. If your debt is the latter, then your RRSP contributions are proportionately more important. If the former, then pay down the debt first.

Debt Payment

You need to be sure that you are at least meeting the monthly minimum on your debt service so that you do not default or face severe interest rate penalties. Past that, set a goal for how quickly you would like to pay off the debt and calculate what monthly amount you have to put toward it. Generally speaking, if you calculate it will take more than 18 months to pay off a high interest, unsecured debt, then make it a priority, and divert at least a part of what you might otherwise have saved in your RRSP.

Tax Return

The really satisfying thing about an RRSP contribution is that it comes with a tax refund guaranteed. If you decide to keep contributing to your RRSP, you can take your tax refund cheque and use it to pay down your credit card debt.

Free Up Income

You probably feel like it’s very hard to both save for retirement and address your debt. Both are important priorities. Take a look at some of your other, less essential spending, and see how much you could free up by economizing or cutting out small luxuries. Then be disciplined about putting that extra cash toward your debt. Once it’s paid off, you can put that extra amount toward your RRSP instead.

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