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The Importance of Contributing Early
The vast majority of Canadians make their contributions at the end of the tax year. By making your RSP contribution either at the beginning of the year-early 2001 for the 2001 tax year, instead of early 2002-or by making regular monthly contributions, you will build yourself a significantly larger RSP. Why, you ask? It's because of the additional years of compound growth that result from making your contribution sooner rather
than later.
Consider 35 year old Tim who contributes $5,000 at the end of each tax year. Assuming Tim continues to contribute until age 65, and assuming an 8% growth rate, his RSP will be worth $566,000 upon retirement. Now consider 35 year old Denise, who contributes the same amount each year, but pays it in monthly installments. Based on the same rate of return, her RSP at age 65 would be worth $587,000. If she made her contributions in a lump sum at the beginning of each year, it would be worth $611,000. In other words, Denise's retirement fund would be $21,000 - $45,000 larger than Tim's, simply because she gave some thought to her RSP earlier in the year.
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Borrowing to make an RSP contribution
While borrowing to invest outside your RSP may provide you with a tax deductible interest expense, borrowing to make an RSP contribution will not. Deciding whether or not to borrow is complicated by the fact that you can carry forward your unused contribution limit to a future year when cash may be available. While carrying forward your contribution will avoid borrowing costs, tax deferred growth must be forfeited. In general, if you expect to be able to repay an RSP loan within one year-this strategy should prove advantageous. Use your tax savings from the contribution to help repay your RSP loan.
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Setting a target
If you are like many Canadians, you endeavor to save as much as possible within your RSP each year. The question that must be asked is, "Will it be enough?". Before you can answer this question you must determine your desired retirement lifestyle. Determining this objective will allow you to set a savings target for your RSP. Setting this target is the only way you can gauge your progress and determine when enough is truly enough.
As a rule of thumb, for every $10,000 in before-tax retirement income, you must accumulate $150,000 in RSP assets by the year of retirement. This assumes that your life expectancy once retired is 25 years, that your income increases at a rate of 3% per year to keep pace with inflation and an 8% growth rate on your investments.
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