Preet Banerjee Globe and Mail Jan 21 2013
Recent polls and studies remind us that many Canadians have lots of credit card debt and little retirement savings. Fortunately, for some people, there is a way to reverse that – almost overnight.
As long as you can commit to running a balanced budget, or ideally a surplus budget, you will eliminate a high-interest debt used to pay for depreciating assets and replace it with a low-interest debt used to fund an appreciating investment.
The idea behind it is simple. Many Canadians can generate a sizeable tax refund by contributing to their RRSPs. Using an online tool, you can figure out, for example, roughly how much you would need to generate a refund large enough to wipe out a credit card balance.
Here’s an example of how it works: John Smith has $5,000 in credit card debt at 28 per cent interest. He calculates that a $12,500 RRSP contribution will generate a refund of $5,000. He was paying roughly $500 per month towards his credit card to cover interest and new purchases, so the balance was perpetually stuck at $5,000.
Using a loan calculator , he finds that a two-year RRSP loan will cost him roughly $550 per month. In his case, the strategy requires him to find an additional $50 per month of cash flow, which he believes he can do as part of his mini-financial makeover.
He still has debt, but instead of paying 28 per cent interest, he’s paying 4 per cent. Instead of nothing to show for his monthly outlay, now he has money invested and growing for the long term.
Like most Canadians, John is much less likely to miss an RRSP loan payment than he is to put a temporary hold on any automatic savings plan he might set up. A temporary hold which may become permanent.
There are no immediate consequences for not making a monthly contribution to your savings. But miss a loan payment and you’ll get a nasty phone call or letter in short order.
It’s important to note that between the time of the RRSP loan and the tax refund, you could be responsible for both the credit card payment and the loan payment. Fortunately, financial institutions that provide RRSP loans routinely offer the option of delaying the commencement of loan payments for three or six months.
This allows you to maintain your cash flow as is until your refund arrives so that you can eliminate the credit card debt, and corresponding payment, before starting the RRSP loan repayments.
If you can avoid running up your credit card balance again, this might be as close as you can get to killing two birds with one stone this RRSP season.
To Your Wealth