As the RRSP deadline looms, a new report by CIBC helps guide Canadians
towards the answer
TORONTO, Feb. 22, 2013 /CNW/ - (TSX: CM) (NYSE: CM) - The number one question Canadians are asking this
RRSP season is whether to pay down debt before contributing to their
long-term savings says Jamie Golombek, CIBC's Managing Director of Tax
& Estate Planning.
"It's the age-old debate - do you pay down debt or save for retirement?
And where does a TFSA fit in? Canadians are increasingly dealing with
more complexity in their financial planning choices," says Mr.
Golombek. "While Canadians' current views are shifting towards debt
reduction, this strategy may not necessarily make sense for everyone."
Mr. Golombek's new report, The RRSP, the TFSA and the Mortgage: Making the best choice, illustrates the various factors Canadians need to consider when making
an informed decision - a decision complicated by increasing household
debt, a low interest rate environment, and the introduction of the
TFSA.
To maximize savings, the report recommends considering five key factors:
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The expected rate of return on your investments
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The interest rate on your debt
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Your current and anticipated personal tax rates
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Your time horizon
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Investment risk
"It's about making your money work harder for you. Factoring in these
five key points can help you save thousands over the long term," said
Mr Golombek. "Remember, it's not about making the perfect decision. No
matter the outcome, you will still be ahead of the game whether you
choose to invest in an RRSP or TFSA or to repay debt, because you are
saving for your future."
Due to the individuality of savings needs, Mr. Golombek recommends
obtaining advice from a qualified expert. A CIBC advisor can help you
evaluate different investment options, review debt interest rates and
repayment considerations, and assess the amount of income that may be
available to you in retirement.
CIBC is a leading North American financial institution with nearly 11
million personal banking and business clients. CIBC offers a full range
of products and services through its comprehensive electronic banking
network, branches and offices across Canada, and has offices in the
United States and around the world. You can find other news releases
and information about CIBC in our Press Centre on our corporate website
at www.cibc.com.
Illustration of how to decide between the benefit of an RRSP, TFSA, and
Debt Repayment
To illustrate this point let's take a look at an example. Suppose you
have $1,500 of pre-tax earnings that is not needed to pay your monthly
bills and an income tax rate of 33.33% today and an expected rate of
20% at retirement. After paying $500 (33.33% x $1,500) in current
income tax, you will be left with $1,000 of after-tax cash flow that
you can use to either invest in a TFSA or to make an additional
repayment against your mortgage. Alternatively, you could contribute
the entire $1,500 to your RRSP and pay no tax until the time of
withdrawal. Suppose that over the long term, you expect to average a 5%
rate of return (ROR) on your equity-based investments and have a
mortgage with a 3% interest rate.
The chart below calculates the increase in your net worth under each of
the three options.
Benefit after one year from RRSP, TFSA and debt repayment
(ROR = 5%, Interest rate on debt = 3%, Tax rate today = 33.33%, Tax rate upon
withdrawal = 20%)
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RRSP
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TFSA
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Debt
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Income subject to tax
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$1 ,500
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$1,500
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$1 ,500
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Income tax (33.33%)
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NIL
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(500)
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(500)
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Plan contribution / debt repayment
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$1,500
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$1,000
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$1,000
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Income earned (5%)
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75
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50
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n/a
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Interest saved (3%)
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n/a
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n/a
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30
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Value of benefit after one year (pre-tax)
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$1,57 5
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$1,050
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$ 1,030
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Tax payable on withdrawal (20%)
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(315)
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NIL
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N/A
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Benefit after one year (after-tax)
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$1,260
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$1,050
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$ 1,030
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This example illustrates the impact that income tax rates, the expected
rate of return on investments, and the interest rate on debt would have
on your benefit after just one year. To fully analyze your situation,
you should project the benefit from an RRSP, TFSA and debt repayment
over your time horizon.
You must also consider investment risk. While you may be assured of
saving 3% interest on your mortgage while this rate is locked-in, the
rate of return on your investments may not be so certain. Although the
example assumes that your RRSP or TFSA investments would generate a 5%
rate of return, this may certainly not be the case over a one-year
period or even over longer periods of time since most equity-based
investments do not provide a guaranteed rate of return. For a true
comparison to the guaranteed interest savings on your mortgage, you
should look to the rate of return on a risk-free investment, such as a
Government of Canada bond, over the relevant time horizon.
Mr. Golombek offers additional scenarios in his report, The RRSP, the TFSA and the Mortgage: Making the best choice.
SOURCE: CIBC
