Debt vs. RRSPs
For many Canadians, the notion of salting away money for their retirement seems pretty farfetched these days. When you're swamped with debt, the prospect of spreading your already-thin cash flow even thinner is about as tempting as the thought of borrowing even more to put into an RRSP.
On average we owe almost 150 per cent of what we earn — our debt stands at about $1.48 for every $1 earned. Each of us is lugging around $25,000 in miscellaneous debt on top of mortgage debt. But even when we have more in pocket and feel confident about job prospects and the economy, humans are generally not that great at planning for the long-term.
The fact that consumers are more focused on coping with debt is reflected in the way banks are tweaking the pitches for their services and products this RRSP season. Although the hard sell on RRSPs is still underway in a very competitive market, it's supplemented by a broader, softer approach. There's a concerted effort to engage clients in a more holistic discussion about setting realistic financial goals, breaking the future into five-year increments and managing money and budgets.
So what should you do: pay down debt or save for your eventual retirement?
Obviously, there's no One Size Fits All answer to that question. Everyone has a very different set of circumstances. But nonetheless, there are a few key questions to ask to get an accurate assessment of your situation — especially at a time of year when you're being pressured to make a choice.
This exercise is best done in bite-sized chunks — so let's break it down for easier digestion:
- Although mortgage debt tends to be categorized as "good" debt, the fact is that you either owe money and pay interest on that money or not. Although for the first time ever, a generation of retirees are heading into their Golden Years with a fair amount of debt in tow, it's far from ideal — especially if you're relying on market-based income to cover your costs when you stop working.
- Interest rates are more likely to rise from current levels than fall. How will that affect the debt you're already dealing with — including your mortgage? If you're paying 30 per cent on an HBC card, should you really be trying to do anything but get rid of that — and then cut up the card?
- Consider the fees that you are paying on the various financial products in your portfolio. Convenience comes at a cost — often a steep one. Paying down debt doesn't require fees.
- Don't forget to constantly sweat the small stuff. It's easy to be focused on the big numbers, but the little ones add up very dramatically. It's just like counting calories, a few extra here and there can really distort your long-term plan.
- Debt-reduction doesn't have tax implications but RRSP contributions are fully taxable when you begin to access them. Granted you may be in a lower tax bracket at that point, but if you've got other income (such as a legacy or an unsheltered cash flow) the advantages can be eroded quickly.
- Real estate markets are hardly immune from periods of volatility, but over the longer-term, real estate does tend to appreciate steadily. According to CMHC, the average Canadian house has gained almost six per cent in value since 1980. Not splashy, maybe, but solid. And that factors in the bumps of 2008 as well.
- When you monetize your investment in a house, the appreciation is not subject to a capital gains tax.
- Without dancing on anyone's grave, are you likely to receive an inheritance or legacy at some point? It's not ghoulish to factor that into your financial equation.
- Realistically, how do you imagine your lifestyle if and when you retire? Is it likely you'll have the same sort of expenses that you're facing now? How might your personal priorities and choices shift? Will you need the 70 to 80 per cent of your pre-retirement income to survive? Obviously, that depends entirely on how much you earn: 50 per cent of $300,000 is a lot more feasible that 50 per cent of $50,000.
- Another consideration is age and the amount of time you have before retirement. Yes, compound interest can be a miracle. But that miracle depends on having your debt under control.
- What other options do you have other than an RRSP? Is a tax-free savings account a more realistic, sustainable route?
- Consider all the angles in terms of who benefits from your ultimate decision on the advice they offer. Everyone has an angle and you need to find your own.