Whether you pay off debt or invest, some strategic planning can help your money go a long way.
IT’S THE BEST KIND OF SITUATION – you have some extra money. Perhaps you’ve saved diligently throughout the year, or it’s arrived all at once as a tax refund. What’s the best way to make use of your windfall?
Of course, the answer depends on your personal circumstances. This article will take a look at a reasonable figure – $5,000 – and some strategies that can help you make the most of it.
Two strategies that can move you closer to debt freedom
More than three-quarters of Canadian homeowners surveyed (77 per cent) say that being free of debt is a top priority. If it’s a priority for you too, one of the best ways to help eliminate debt is to put as much as you can towards debt repayment.
1. Pay off consumer debt
Consumer debt (which includes credit cards, loans and lines of credit) often comes with a higher interest rate than your mortgage, so that’s a good place to start. Canadians were carrying an average of $21,164 in non-mortgage debt in mid-2015.
Check your statements to identify your highest-interest debt and consider applying a substantial amount of your extra money towards that balance. Paying off a $3,000 credit card balance charging 19.99 per cent, for example, can save you nearly $560 in the first year. By contrast, if you continued making only minimum payments, it would take more than 17 years to pay off the balance and cost close to $3,500 in interest.
2. Pay down your mortgage
The biggest debt for many is often a mortgage. Across Canada, the average mortgage balance is about $175,000. If your mortgage allows lump-sum prepayments, consider allocating the extra funds towards the principal. You could save hundreds or even thousands in interest and be a step closer to paying off your mortgage.
Three savings strategies that can help you achieve your dreams
What financial habit do Canadians find most stressful? In a recent poll, 43 per cent answered “not saving money.” If saving is important to you, set some cash aside for one of these objectives.
3. Save for retirement
Money can grow quickly inside a Registered Retirement Savings Plan (RRSP), because you don’t have to pay any tax on investment growth until you make withdrawals.
Assuming you have contribution room available, $5,000 invested in an RRSP today, earning an average rate of return of six per cent and compounded annually, will grow to almost $29,000 in 30 years. That’s a tidy sum to put towards your retirement lifestyle.
Don’t forget you also get a tax deduction based on your RRSP contribution, which may mean a refund the next time you file your taxes – and another windfall.
4. Save for a short-term goal
Many of us have a mix of short-term goals. You may be saving for a down payment on a home, a new car or a dream vacation. Or you may want to build up an emergency fund.
Consider stashing extra cash in a Tax-Free Savings Account (TFSA) for these types of goals. Any investment growth accumulates tax-free, and the money can also be withdrawn tax-free. One of the best features of a TFSA is that you can take out money to finance a short-term goal and then recontribute the same amount in the following calendar year. In other words, you don’t lose your contribution room when you withdraw.
5. Save for education
If you’re saving for a child’s post-secondary education, you can get a head start by investing in a Registered Education Savings Plan (RESP). An RESP offers what is essentially a guaranteed rate of return in the form of Canada Education Savings Grants (CESGs), which match 20 per cent of up to $2,500 in contributions each year.
If you didn’t contribute last year, and you contribute $5,000 this year, you could receive $1,000 in CESGs. Over 10 years, earning an average rate of return of five per cent and compounded annually, that $6,000 could grow to over $9,700.
Speak to your advisor
The best approach for you will depend on your financial situation and your priorities. Your advisor can help you decide which strategy, or which combination of strategies, can help make your extra money go further.