February, 2009
The Second Opinion: Tax Season: Part Three
Last Minute RRSP Contributions
‘Tis the season—for last-minute RRSP contributions!
Under the RRSP rules, contributions made within the first 60 days of 2009 can be counted as a contribution for 2008 and thus be eligible for a tax deduction on your 2008 tax return. Every year there is a rush of investors looking to make that last minute contribution—often the only contribution made all year.
But is a once-yearly, last-minute RRSP contribution really the best way to save for your retirement? We think not.
There are several reasons why last minute contributions are a bad thing. Firstly, according to The Financial Advisors Association of Canada (or Advocis for short), people who wait to the last minute often save less than people who save a smaller amount each month. One of the reasons is that “RRSP Season” is immediately after the holiday season. Many people overspend during the holidays and are too worried about paying off the credit card debt they amassed to even think about their RRSP. Secondly, because the contribution is made at the last minute, often how that contribution gets invested is also a rushed, last minute decision. People may decide to stick with the status quo instead of really thinking about their investment strategy, costing them uncountable fortunes in lost returns.
A monthly savings plan is a better alternative than last minute contributions for several reasons, not the least of which is that it allows you to take advantage of dollar cost averaging. By putting a set amount of money in the market each month, you are buying more shares when prices are low and fewer shares when prices are high. This averages out so that, over time, your shares are being acquired at reasonable prices and you can expect reasonable returns.
Monthly savings programs can be set up at most financial institutions so that a set amount of money is automatically taken out of your account each month and invested in a mutual fund or managed account of your choice. For best results, ask to have the money put into broad-based index mutual funds. Perhaps one of the best features of this strategy is that after a few months of withdrawals from your account you won’t even miss the money because you will adjust your lifestyle expenses. Furthermore, you can gain peace of mind by knowing that you are on track to financial independence.
Despite monthly savings being superior to last minute contributions, if you have not made your RRSP contribution for 2008 you still should, last minute or not. However, going forward, a monthly savings program is the better alternative.
In order to start a monthly savings program you should first determine how much you need to save each month in order to achieve your retirement goals. This is easily determined through a simple financial plan. As a starting point, read Warren MacKenzie’s tip “Determine How Much You Need To Save”, found below. A link to Advocis’ consumer information on the benefits of year-round RRSP contributions is also found here.
By Carlo Palazzo, CIM
Advocis: Benefits Of Year-Round RRSP Contributions
Read the article here.Determine How Much You Need To Save
Why this is important: If you do not have a plan, you may feel that the goal of financial independence is out of reach. A plan that breaks the big objective down into small monthly targets makes the task easy, satisfying, and rewarding.
You are not likely to reach a financial goal unless you know how much you need to save each month to achieve that goal. If you don’t know the amount you have to save, you have no way of knowing whether you have done enough, or whether you are even on the path to success.
When you save the amount you need, you get two rewards. First, you are closer to achieving your goal. Second, you feel satisfied and accomplished. You feel proud of yourself.
The reward for setting aside the necessary amount each month is much greater than simply achieving financial independence. You also have the sense that you are in control of your life.
Knowing how much you need to save allows you to make fundamental choices. For example, if you knew you needed to save $600 per month to retire by age 65 or $1,000 per month to retire by age 55, you might decide that an additional sacrifice would be worth it in order to leave work 10 years earlier.
For some people, saving an additional $400 per month would be considered a good trade if it meant retiring much earlier. But if they are unaware of the opportunity, they are unlikely to act. Some day they may wish they had known that a simple change in lifestyle would have given them financial independence five or ten years earlier. Let’s hope Carolina Edwards, author of Money Doesn’t Grow on Trees, isn’t describing you when she says: “Many otherwise intelligent adults save for retirement the same way they studied for exams: Wait until the last moment and cram.”
Bottom line: You need a plan that tells you how much you need to save each month to achieve your most important financial goals. If you know what you have to do — and you are doing it — you are in control and your whole life changes.
What you can do now: Start the process by getting a financial plan that shows how much you need to save to achieve your long-term or important financial goals.
