Pay Yourself First with Pre-Authorized Contributions

Written by Preet Banerjee

Wednesday, September 26th, 2018

If you get a regular paycheque, wouldn't it feel great if the income tax deduction disappeared? Let's say you have $200 deducted from your take-home pay every two weeks, but now, all of a sudden, the deduction stops. Sounds great, right?

The catch is that you'd still have to pay your fair share of income taxes for the year. And at $200 every two weeks, that works out to $5,200 for the year. So you'd have to pay that to the government in a lump sum when you file your taxes in April.

When I ask most people which scenario they'd prefer (I'm super fun at parties), they invariably choose the status quo, to have the tax deducted from their paycheques. Why? Because they know the only way they can pay that much in tax is if it happens automatically, on a regular basis.

We know we have to pay tax, and this tends to be the least painful way to do it.

Taxes are Mandatory, RSP Contributions are Optional

One big difference between income tax and RSP contributions is that income tax is mandatory, but RSP contributions are optional.

The deadline for contributing to an RSP is the 60th day of the calendar year. Getting your contribution in by the deadline means you can deduct what you contribute from your previous year's taxable income on your tax return, which is why some people scramble to come up with money to contribute to their RSP, often in a lump sum, right as we're still getting the credit card bills from the holidays.

So by waiting until the last minute to make an RSP contribution for the previous tax year, since nobody's going to slap us with penalties if we can't find any money to contribute, guess what? We under-contribute.

Slow and Steady Wins the Race

To increase RSP contributions, it's best to harness the power of paying a little at a time, just like we do with our income taxes. Another example of this is the renter whose landlord has just announced rent is going up $50 per month. The renter will get a bit mad, but they likely won't move. It's too much of a hassle. They'll just suck it up and find a way to pay the extra $50 per month. Over the course of a year, that's $600, but after the first few months, the renter may not really notice it. It becomes the new normal.

How Much Discretionary Income?

Let's work backwards. How much of your income is ideal to contribute to your RSP annually? If you have no idea, aim for 10% of your income to start. So if you're earning $50,000, then 10% of that would be $5,000. Divide that by 52 and set up a weekly Pre-Authorized Contribution (PAC) plan to your RSP. In this case, that works out to $96.15.

I know almost $100 per week sounds pretty steep, but another mental hurdle I sometimes see is that people think of these regular contributions as "spending". They're not. The money isn't gone, it's just allocated for future spending. And hopefully a lot more of it, because the money ideally grows over time.

Act First, Ask Questions Later (Dollar-Cost Averaging)

That's normally horrible advice. But in the case of making investment contributions, it may be a different story. If you find that setting aside 10% of your income is too much after trying it for a few months, you can always decrease that amount.

And when it comes to investments, for people who worry about whether the timing is right to invest, this automatic approach removes those concerns. Since you'd be investing a fixed amount of money regularly, in case of a downturn in the market, your regular contribution amount ends up buying you more units than the month before, since your money will buy more units when the price drops. This is often referred to as dollar-cost averaging.

I've never met anyone who complained about saving too much over their lifetime, but I've met plenty of people in the opposite camp. Think about setting up automatic contributions for your retirement instead of using lump sums before the RSP deadline. After a few months, you may not really feel the contributions anymore, but you'll likely end up saving more than you thought you could.

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