Whether Alex contributes $500 each month or $6,000 at the deadline, the amount and tax benefit are the same. But there might be other advantages. What if Alex finds it hard to come up with $500 every month? Sarah suggests a way to make that a little easier.
She suggests Alex make regular contributions throughout the year through payroll deduction. This way, the money comes out of his paycheque, automatically. No more scrambling to find money in late February.
What is the tax benefit of making payroll deductions?
Sure, contributing a lump sum at the deadline may mean a big tax refund. But that just means paying too much tax all year long.
Sarah recommends Alex make regular monthly contributions through payroll deduction. He can ask his employer’s HR department about setting this up.
How does a payroll deduction work? RRSP contributions will come directly out of Alex’s gross income. He can ask his employer to be taxed at his adjusted income*. That way, Alex can access his yearly tax refund on every paycheque. That would give Alex more money each month to afford a contribution.
*Adjusted income in this example means Alex’s gross income less the amount he contributes to his RRSP.
What is price averaging and how can it be a winning strategy?
There is another interesting advantage to investing in a RRSP on a regular basis, Sarah explains. It’s called dollar-cost averaging*.
*Dollar-cost averaging means investing regularly and presuming the markets will fluctuate. The average here refers to the cost of investment funds the same dollar amount can buy from one investment to the other.
Alex contributes to his RRSP by investing in mutual funds. Investing the same amount on every paycheque means buying at different stages in the market. There will be times he invests when the market goes up and when the market goes down. So, he’ll be buying more fund units when prices are low, and less when prices are high