Pay off debt or save for retirement?

Pay down debt or save for retirement?The fairy tale, debt-free retirement for the average worker is ending as Canadians find themselves overwhelmed with debt when they retire. So, should Canadians be forking away their savings into registered retirement savings plans (RRSPs) when they already owe too much?

According to the Bank of Canada, Canadian consumers could be accumulating too much debt. Recent data show that Canadian household spending averaged $71,360 in 2009, a 2 per cent increase from 2007. Of that, about 20 per cent represents tax-free shelters such as RRSPs and tax-free savings accounts.

Historically, financial advisers recommended saving up for retirement. However, in today's economic environment, Canadians are carrying debts that accumulated while they were struggling to keep up with living expenses. As they got back on their feet, they were overwhelmed with huge loan payments.

The traditional advice that once held five years ago has been tossed out the door. It's time to pay the piper and then make contributions to your RRSP.

"You cannot go into retirement with debt," financial adviser Judith Cane told The Canadian Press. "Paying down consumer debt is just as important as building up a financial buffer for retirement."

It's a bad idea to get a loan to make a contribution to an RRSP if you already have significant debt, she adds. The money that comes back to you will have to be used to pay down the loan, and you won't be any further ahead as loan costs are higher.

The decision to contribute to an RRSP is contingent on many factors, including age, marital status, job situation and debt load. A person in their 20s could forgo the RRSP contributions if they find themselves with significant credit card debt. They should focus on paying off the debt before signing on for an RRSP. A person in their 40s should contribute steady amounts into an RRSP while paying off their debt as quickly as possible.

Jamie Golombek from CIBC Private Wealth Management has excellent advice on how to save money in today's challenging times: Tax-free savings accounts should become the "No. 1 source" for retirement savings, as long as the federal government doesn't change the rules governing them. Anyone over 18 can deposit up to $5,000 of savings per year without being taxed on the earnings.

People in a low tax bracket should take full advantage of their tax-free savings account before making deposits into an RRSP, he adds. With a tax-free savings account, when you withdraw funds, they are 100 per cent tax free.

However, if you find you are able to put your $5,000 a year into a tax-free savings account and still have savings left over to buy an RRSP, then go ahead and do both, he advises. RRSPs not only decrease income tax paid initially, but also are a tax deduction and a tax deferral at a lower rate when withdrawn at retirement.

At the end of the day, every Canadian should pay off their debts first before worrying about building up their retirement fund.
Published March 24, 2010

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