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All trading basics

Contribute Early, Contribute Your Maximum

Two people both contribute $45,000 to their RRSP. The first person begins contributing $1,500 a year at age 25 and continues to do so for 30 years. The other begins contributing $3,000 a year at age 40 and continues making contributions for 15 years. Although they've both invested the same amount, the first contributor will have accumulated a great deal more at age 55 than the second:

Annual ContributionTotal InvestmentValue at Age 55
$1,500/year from age 25 to 55 $45,000 $129,562
$3,000/year from age 40 to 55 $45,000 $72,547
(Our example is based on an 6.5% annual return.)

RRSPs are easy to understand: They put time on your side. Your savings grow tax-free, which improves your return. The longer your money stays in this tax shelter, the higher your retirement capital. This is why you should start contributing to your RRSP early in life.

It is not always easy for graduates new to the job market or for young families to invest for their retirement, when it is still years away. However, it is very important to contribute early and to contribute your maximum, regardless of how much your actual contribution is. If you contribute early in the year, you will earn more. Always remember: time is your best ally!

Contribute Your Maximum

For any given tax year, the law allows you to contribute an amount equal to 18% of your income from the previous year. Always try to contribute your maximum.

If you have not contributed your maximum in previous years, you have unused contribution room, which you may now use, particularly worth considering if you have come into an unexpected windfall. You can even borrow money to compensate for your unused contribution room.

Contribute by Regular Instalments

To contribute a significant amount annually without straining your budget, try to contribute throughout the year and avoid the February rush.

This way, your capital will be in a tax shelter for a longer period of time since your contributions will earn interest from day one.

Select the regular instalment plan where your contributions are withdrawn directly from your account. You'll see: a few dollars each week or month will add up. All you have to do is authorise your caisse to withdraw the amount you choose as often as you like. You can change the amount and frequency any time you wish.

This is how your contributions can grow:

Weekly $10 contribution
Time SpanCapital InvestedValue of RRSP
After 10 years $5,200 $7,239
After 20 years $10,400 $20,797
After 30 years $15,600 $46,193
Weekly $50 contribution
Time SpanCapital InvestedValue of RRSP
After 10 years $26,000 $36,193
After 20 years $52,000 $103,985
After 30 years $78,000 $230,966

These examples are based on an RRSP investment at an annual rate of 6.5%.

Use Your Unused Contribution Room

If, for a given tax year, you do not make your maximum RRSP contribution (generally 18% of your income for the preceding year), you will have unused contribution room that you can use in subsequent tax years.

For example, if your maximum contribution for a year is $10,000 but you only contribute $2,000 to your RRSP, you may use the unused $8,000 portion to increase your contribution the following year for a total of $18,000 (assuming your income hasn't changed).

In other words, when you use it, your unused contribution room lets you exceed your maximum annual limit, which is $15,500.

Information about your unused contribution room appears on the maximum RRSP deduction statement that you receive every year from the Canada Revenue Agency.

If you should come into some money unexpectedly, (inheritance, lottery winnings, bonus or other) it may be wise to use your unused contribution room and put this money in your RRSP. In some cases, you can even borrow to use your unused contribution room.

Excess Contributions

By law, you are allowed to contribute up to $2,000 over your maximum, without penalty. The exceeding amount cannot be deducted from your taxable income for the current year but it can be deducted for subsequent years.

Borrow to Invest

In some cases, it may be to your advantage to borrow money to invest in your RRSP.

For example, suppose your taxable income is $50,000 and you want to contribute $2,000 to your RRSP this year. Let's see what happens if you borrow $8,000 to raise your contribution to $10,000 (and this contribution is within your legal limit).

Our example is based on the hypotheses that it is a 5-year loan at 7.20% interest, and it is based on the 2007 tax schedule.

This $10,000 contribution will entitle you to a tax refund of $3,837, which you would immediately use to pay back a portion of the loan, bringing your balance to $4,163 ($8,000 - $3,837).

You would then have five years to pay the balance which, at term, will have cost you $5,020*, including interest!

In 10 or 15 years, you will be happy you contracted this loan. Look at the following table and compare both contribution amounts, assuming an annual return of 7%. The numbers speak for themselves!

Time SpanValue of $2,000 contributionValue of $10,000 contribution
10 years $3,934 $19,672
15 years $5,518 $27,590

* The loan refund is calculated over an amortisation period of 5 years, with payments made weekly at a rate of 7.20%, considering that the tax savings is used to reduce the loan after 8 weeks - the period between the end-of-February contribution and the approximate date of the tax refund.