Today's show is a rebroadcast from Season #1. It's one of our most down-loaded shows, because it answers a common question: Should I pay down my debt, or contribute to my RRSP? The answer is not always obvious.
We all know that investing in an RRSP generates a tax refund. If you are in the 40% tax bracket, a $1,000 contribution to your RRSP generates a $400 tax refund. (Of course I'm over-simplifying this example; your actual tax refund will depend on your marginal tax rate, and many other factors). $400 sounds great, so why would I ever use that $1,000 to pay down debt? Isn't the RRSP contribution always the best answer?
As we discuss on the show, this is largely a math question. The RRSP contribution generates a one time tax saving; in the previous example, you only get the $400 deduction once. Paying down debt saves you interest in all future years.
For example, if you owe $1,000 on a credit card with a 20% interest rate, you will pay 20% in interest this year, or $200. If you only pay the interest, you will still owe $1,000 next year, and will pay $200 next year, and the year after. So by paying down your credit card by $1,000 you save $200 every year, which is mathematically better than only saving $400 once.
Of course this is not a real life example. I'm ignoring the investment income you can earn in your RRSP, and I'm ignoring the fact that you may be paying more than your minimum payments on your credit cards even within the one time $1,000 pay down. The point is that each situation is unique, so you should crunch the numbers and calculate the option that is best for you.
Learn more by listening to the podcast or reading the transcript: Show #32 - Full Transcript - Pay Down Debt or Invest?
- Chilton Takes a Swipe at Reverse Mortgages
- Financial Literacy: What it is, Why it Matters
- Pay Down the Mortgage? Or Build up your RRSP?
- Six Ways to Avoid 'Roaming' Shock on your Wireless Bill