Matt and Jessica are a young married couple living in Edmonton. Matt, 26, is a junior high school teacher who loves his job and earns 55k per year. Jessica, 24, has been working as an engineer for the last three years, and earns 65k per year. After two years of marriage, they’re thinking of starting a family soon, which means they’re ready to settle down and buy their first home.
While this couple’s combined household income totals 120k annually, they’re concerned about their financial future; housing prices are rising, the economy looks uncertain, they both have student loans to pay off. Fortunately, thanks to RRSP matching programs from both of their employers, they’ve been able to start saving for retirement already, but now they’re wondering if their priorities are in the right place. This couple is financially savvy, but they also have plenty of questions; here’s how we would advise Matt and Jessica how to manage their RRSP savings.
Paying Off Debt vs. Contributing to RRSPs
Part of this couple’s dilemma about their retirement savings is the fact that they both still have student debt to pay off. While they’d like to get out of debt, they also want to make sure that they’re not setting themselves up for financial failure in the future.
“This couple will end up with more money in the bank if they focus on paying off their high interest loans before worrying about low interest investments like RRSPs.”
For Jessica and Matt (and couples like them), the answer is typically to focus on debt repayment first, even if this means putting less into your retirement savings for a while. Part of the reason for this is because of the relative level of interest rates. Debts like student loans usually come with fairly high interest rates, while RRSP investments, especially when you’re in your 20s, come with lower interest rates. So all things being equal, this couple will actually end up with more money in the bank if they focus on paying off their high interest loans before worrying about low interest investments like RRSPs.
Using Your RRSP to Buy a Home
While student loans are on Jessica and Matt’s minds rights now, they’ve also been thinking a lot about buying their first home. After several years of diligent saving, plus a little help from their parents, they’ve managed to set aside a home buying fund of $24,000 – enough for a 10% down payment on a two-bedroom condo. This would get Matt and Jessica the property they want, but also leave them with a high-ratio mortgage. Before making leap to become homeowners, Matt and Jessica should consider other ways to free up funds to increase their down payment and avoid the high-ratio mortgage scenario.
Fortunately for Matt and Jessica, there’s a program they can use to free up funds from their RRSP to use for their down payment. It’s called the Home Buyer’s Plan (HBP), and it’s only for first time homebuyers. Through this program, Jessica and Matt can each access up to $25,000 tax-free from their RRSP to use towards a down payment, on the condition that they repay these funds to their RRSP over the next 15 years.
Over the last four years, Matt has been putting 5% of his income into his RRSP. Thanks to his employer’s matching fund and the interest he’s accumulated, he’s built up over $23,000 in retirement savings so far. Jessica has also been putting 5% aside each month over the last three years, for a total of $20,000. This means they have over $43,000 in retirement savings already, $50,000 of which they can access through the HBP. If they decide to take out $24,000 using the HBP, they can increase their down payment to 20%, which will give them a lower ratio mortgage, and also leave them a healthy amount in their retirement savings. The only catch is that they have to be sure to keep up with their RRSP payments in the future to pay their down payment money back.
Finding the Right Balance
The RRSP plan for this couple is all about finding the right balance between short term and long term goals. While it may make financial sense to leverage your RRSP for short term goals like paying off debt or buying a home, you don’t want to lose sight of your long term goals either. Matt and Jessica may decide that they want to prioritize debt repayment right now, which means they could defer their RRSP contributions for a while and focus on paying off student loans instead. Or, they may decide that buying a home is their biggest priority, and opt to use their RRSP to help with their down payment. Either of these options will help keep their interest payments lower in the future, which will leave them with more money in the bank.
“A good way to make sure you’re not neglecting your retirement savings is to set up automatic contributions every month.”
The problem is that all of this extra cash won’t help them with their retirement savings unless they reinvest it in their RRSP. In fact, Canadians who don’t make the minimum annual repayments required by the HBP will be penalized on their income taxes. That’s why it’s important to create a retirement savings plan as soon as you can, even if you’re using your retirement savings for other purchases.
A good way to make sure you’re not neglecting your retirement savings is to set up automatic contributions every month. For a couple like Matt and Jessica, a good starting point would be for each of them to contribute around 10% of their monthly salaries to their RRSP fund. Then, as their salary and income level rises, they can revisit that amount.
If this couple sounds familiar to you, you may want to follow some of this advice for yourself. Of course, not everyone is the same Matt and Jessica, which is why we offer customized financial planning services for all Albertans, no matter their age or income level. Want to know what to do with your RRSP? Get in touch with one of our financial planners and we’ll help you create a personalized financial plan that will help you achieve all of your short and long term financial goals.