How Pre-Authorized Contributions Can Simplify Investing
Written by Al Emid
Thursday, September 27th, 2018
When it comes to effective Retirement Savings Plan (RSP) strategies, pre-authorized contributions (PACs) can help you reach your investment goals.
With a PAC, a fixed amount is contributed regularly to your RSP. You can select the amount and frequency, and the contributions happen automatically.
The Benefits of a PAC
1. It Takes Care of Itself
PACs make it easy to keep your RSP contributions up-to-date, since you can set the amount once and not have to worry about where you stand with your contribution amounts. "To me, it's the regularity of getting and then forgetting it," explains Roy Vokes, Manager of the Worldsource Financial Management branch in Nobleton, Ontario. "People get used to [automatic payments for] cell phones, so why not do it with the RSP?" he asks.
2. Saves the RSP Deadline Panic
Because you're now regularly contributing, there's no need to make a huge lump sum contribution when the RSP contribution deadline approaches. It takes a lot of stress out of the equation.
3. Ease of Budgeting
The flexibility of a PAC allows you to create a solution that best fits your needs. You can determine a regular amount that works for you.
Despite the potential advantages, be careful not to overextend yourself financially. "Make it realistic and, if anything, undershoot until you get used to it, and then figure whether to do it a bit more rather than the other way. Don't set your sights too high and get discouraged," Vokes advises.
4. You Have Control
If it becomes too much to regularly contribute, you can change the amount at any time. You can choose to raise or lower your contribution—you're in control.
5. Dollar-Cost Averaging
If you're investing in securities, PACs also bring the benefits of dollar-cost averaging. What that means is that, since you're investing a fixed amount regularly, you automatically buy more units when the price is low and fewer when the price is high. It takes away the worry of trying to time your investments based on how the markets are performing.
PAC Tax Information
Typically, your RSP contributions are claimed on your income tax return as a way to lower your taxable income and potentially get a tax refund. However, some people prefer to have less tax deducted by their employer at source. There are two ways that a PAC could help do that.
Scenario 1: Your employer deducts the PAC from your paycheque and makes contributions to your RSP on your behalf. In this case, it's no longer necessary to apply to the Canada Revenue Agency (CRA) for permission to reduce the tax deduction, since your employer can calculate the tax based on your income, minus the PACs. Since 2001, the CRA has not required a formal application in this scenario.
Scenario 2: If your PAC goes directly to an RSP at a financial institution, you can document the contributions and apply for a letter of authority from the CRA. This means your employer can reduce the taxes withheld, possibly increasing funds available for non-registered investments.
A word of caution: Reducing your income tax withheld at source can increase your available funds, but Vokes cautions that it may cause other problems. If you have other sources of income, such as taxable investment income or a part-time job, you may get a jolt at tax-time and find that the lower tax deduction gave you a false sense of security. It's also important to note that some employers only agree to the reduction if the PACs go into an RSP they provide or manage. "Also, if you stop [the PAC], you're going to have a tax bill at the end of the year," he says.