Should new grads pay down debt or start saving?
by Terry Bennett, Money Coach, Mac’s Money Centre
The most common question I get asked by new graduates is whether they should pay down their student debt or begin a savings/investing plan.
With the RRSP deadline looming, increasing debt loads and the pressure to fund retirement plans, the time has come to review your options. Debt reduction and wealth building are both important and necessary to one’s future financial health. Reducing your debt leads to less stress, more available cash, and a greater ability to weather personal or economic downturns.
Investing, in contrast, can bring another income stream. Investing acts as a hedge against inflation and can cushion you as you move forward financially.
Building a retirement nest egg may seem like a concern that’s just too far in the future to bother about today. With the pressure to start a family, buy a home, or your own personal goals to travel abroad or further your education, savings plans that are intended to fund your retirement might not be the priority.
Here are two variables that need to be considered when deciding whether to attack your debt or save for retirement. You need to know:
- The interest rate you are paying on your debt.
- The anticipated return on your investment
In other words, the cost associated with repaying the loan vs. the amount your investment is earning. If your investments are earning a higher interest rate than what your debt is costing you, then investing is worthwhile.
There is still a risk involved with investment. How confident are you that your portfolio or business endeavours will consistently outperform your debt expense? This is where an RRSP can be helpful because it has the added bonus of providing you with income tax savings.
An RRSP is a tax deferral plan that allows to you put money into investments while lowering the amount of income tax that would otherwise be paid on these funds. You will eventually pay these taxes when you take these funds out at a later date. The intended outcome is that you are contributing to the plan when your income tax rate is higher than it will be at retirement.
The government introduced RRSPs as a way to encourage Canadians to save for their retirement while gainfully employed. These plans ensured that once you stopped working there would still be funds available during these leaner years.
If you can use a RRSP to lower your taxable income and get a decent return on your investments held in it, then the combined savings makes a strong case for investing; however, RRSP”s aren’t for everyone. If you are anticipating that your income levels now will not change appreciably at retirement than TFSAs are probability a better bet.
As a new graduate, you may have a very low marginal rate. A marginal rate is the percentage of tax applied to your income for each tax bracket. If this is the case, a suggestion would be for you to save money in a TFSA (any interest gained from your invested funds grows tax free) and take advantage of the RRSP in a year when you have a higher marginal tax rate. This decision ensures that you continue your commitment to saving but strategically it makes more sense to use the tax savings when your income and therefore tax savings will be greater.
If you do contribute to an RRSP and get a tax refund, one suggestion is that you put those monies toward your debt. You are then meeting both goals of debt reduction and saving.
If you’d like to discuss this further, please make an appointment with the Money Coach at Mac’s Money Centre.
