Why debt-ridden Canadians should forgo RRSP contributions
Investment industry marketing campaigns are on the rise in an attempt to convince Canadians to contribute to their registered retirement savings plans before the March 1 deadline.
RRSP season brings big commissions for the industry, but for the millions of Canadians drowning in debt, it could bring hardship as interest rates inevitably rise.
The average Canadian household currently owes $1.77 for every dollar earned, according to Statistics Canada. Despite a slight decline at the start of the pandemic, the debt-to-income ratio fell from less than 90 cents in the 1990s.
Most are mortgage debt at manageable interest rates below 5% per annum; but if you take that out, Canadians owe over $24,000 per capita in non-mortgage debt. This includes student or consumer loans, where interest rates often exceed 10%, and credit card balances, which often exceed 20% on outstanding balances.
According to the latest figures from Statistics Canada, credit card balances grew by more than 20% per year between 2000 and the start of the pandemic. In February 2020, Canadians owed a total of $90.6 billion on their credit cards, up from $13.2 billion in 2000.
The appeal of RRSPs lies in the ability to protect investments from taxation until they are withdrawn at a low marginal tax rate, normally in retirement. The overall tax savings can be enormous for Canadians taxed at high marginal rates; but for most Canadians, the tax benefit is minimal.
Tax savings aside, a dollar invested in paying off higher interest rate debt beats a dollar invested in the markets – hands down. No investment can generate a guaranteed return of 10% like paying off debt at a rate of 10%. Any qualified investment adviser knows this.
Registered investment advisers are required to ask potential clients what their debt is under the know-your-client rules. However, they are not required to recommend debt repayment as an alternative to contributing to an RRSP – even when it is blatantly obvious.
According to the Ontario Securities Commission (OSC), in the event of “excessive levels of debt”, advisers must refuse to provide an investment product or service to a client, but the OSC does not guidelines or definitions on what is considered excessive levels of debt. debt.
Some advisors do; even going so far as to recommend debt consolidation plans tied to low-interest home equity lines of credit (HELOCs) to reduce debt faster, but most only get paid when they sell debt products. investment.
There have been calls for the OSC to draw a line in the sand and enforce it, but getting the financial industry to self-regulate can be a monumental task. While the big banks rely on the interest on the loans they make – and the credit cards they offer – to generate revenue, they simultaneously generate revenue from the products they sell from their business arms. ‘investment.
The two functions are meant to operate independently; but banks are even filling this gap directly by offering their customers loans to contribute to their RRSPs.
If you’re hesitating between paying off your debts or investing this RRSP season, don’t ask an investment advisor. Compile your debt and work out some numbers to determine the dollar amount of compound interest each year – and keep in mind that one of the only comparable, guaranteed returns on an investment is a guaranteed investment certificate (GIC), which pays about one percent.
If the task is overwhelming, ask a licensed debt counselor. Depending on an individual’s situation, it often makes sense to do both if the debt is under control.
Remember that the March 1 RRSP contribution deadline only applies if you want to reduce your 2021 earnings. Contribution space can be carried over to the current year or any year coming when your debt is more manageable.