Is there anything that makes you feel as rich as getting the first pay cheque from your first “real” job? You know – the job where you didn’t have to wear a paper hat on your head and actually wanted to tell people about?
Well one of the first things you should do with that money is contribute to an RRSP. That way you’ll get to hold on to more of the money you’re now earning.
You see, when you contribute to an RRSP, you don’t have to take the tax deduction in the same year you make the RRSP contribution. You can defer your RRSP tax deduction to another year – such as one of those years when you’re making more money, giving yourself more of a tax break.
And if your new pay cheques have you dreaming of buying a house, an RRSP can help you do that, too. Use an RRSP to put away money and then when the time comes, you can withdraw up to $25,000 from your RRSP to purchase a home. (See the Canada Revenue Agency’s Home Buyer’s Plan guide for details.)
And then there’s – you guessed it – retirement. The plain fact is that the sooner you start contributing to an RRSP, the more money will be in the RRSP at the end, when you want to start withdrawing money from it to live on.
That’s easy enough to understand. Basically all the RRSP contributions you make over the course of a year count as one RRSP contribution each tax year, and, because you have to stop contributing to an RRSP at age 71, there are only so many years you’re able to contribute.
If you start contributing to an RRSP at age 41 and put $1,000 into an RRSP each year, you will have made 30 annual contributions by the time you are 71 and have put away $30,000.
But if you started contributing to an RRSP at 18 instead and did the same thing, you would have made 53 contributions and have put away $53,000.
That’s not really the way it works, though, because putting your money in to an RRSP has a huge advantage over shoving your money under a mattress; the money in an RRSP earns interest and compounds. So in real life, if you contributed $1,000 each year for 30 years in to an RRSP that earned a 5% return, you would have $69,761, which is a whole lot better than $30,000.
Now here’s the big thing that most people don’t realize; when you contribute the money really matters.
Let’s take a closer look at the 30 years of contribution scenario.
Suppose that over the course of the 30 years, you contributed $1,000 the first 15 years, and then nothing the next 15 years. With a 5% return rate, you would end up with $47,103 in your RRSP.
Then turn it around and suppose that instead, you contributed nothing the first fifteen years, and then$1,000 each year for the next 15 years. With the same 5% return rate, this time you would end up with only $22,658 in your RRSP – less than half than you would have if you had contributed when you were younger! (See this comparison in chart form.)
Okay, you’re convinced. Good! Setting up an RRSP account is easy. When you’re ready to make your RRSP contribution, just go to any bank , credit union or other financial institution and tell them what you want to do.
You don’t have to make a hefty donation at this point to make a difference. The $1,000 mentioned in this article is just an example. Five hundred dollars, $250 – whatever amount you can put away right now will make a big difference later on.
And when you’re ready to do your income tax, don’t forget that SnapTax, the super easy way to get your income tax completed and filed using your iPhone, handles RRSP deductions. Don’t have an iPhone? TurboTax Online is also easy to use and will help you maximize your income tax deductions.
Oh and the rest of that first real pay cheque? Definitely some kind of celebration is in order.