Q: Toward the end of January I expect to receive my annual bonus from work. Like previous years, I plan to put it into my RRSP. Our budget is tight, especially with my wife still on maternity leave, but since the bonus money is never guaranteed, we figure we should save it before we spend it. However, when we were at the bank the other day, the adviser recommended contributing every time we get paid, rather than just once a year. Is that really a better idea? ~Carson
A: Setting money aside in savings, regardless of the frequency, is a habit that has fallen by the wayside for many Canadians during these years of high living costs. Even when working to pay down debt, it’s essential to save at least some money for emergencies to avoid going back into debt to cover the expenses when they occur.
If contributing to your savings only once a year when you get your bonus, rather than every time you receive your income, is the only savings you can muster, then stick with what works for you. However, investing regularly on a more frequent schedule has key benefits over a single annual contribution.
The magic of compound interest
Contributing to your savings account frequently allows you to take advantage of compound interest, which is the interest you earn on the principal you invest plus the interest you earn on the accumulated interest. It is a powerful tool to grow your savings, and the earlier you start, the more time your money has to grow. By contributing to your savings account every time you get paid, you can maximize the amount of interest earned and grow your savings faster.
For example, if you begin with $2,500 and invest it at five per cent with interest compounded annually, and contribute an additional $1,300 once a year ($50 times 26 pay periods), after 25 years your investment would be worth about $70,500. However, if you invest $2,500 at the same interest rate of five per cent, but with interest compounded monthly, and $50 contributed biweekly, after 25 years your investment will be worth over $73,200.
There are many different types of savings accounts and investments, and compounding applies to all of them. You can stretch the magic even further if your employer offers an RRSP matching plan. That’s like doubling your money before you even invest it, so be sure to take advantage of any matching plan to the maximum percentage possible. Calculate compounding for yourself to discover how the magic can help you reach your savings goals more quickly.
Saving regularly becomes a hard habit to break
It’s much more fun to brag about a new car or show off vacation pictures from a fancy resort than to watch your savings grow silently in the background of your life. However, the habit of contributing to your savings account every time you get paid can give you peace of mind that you are in control of your finances.
Setting savings aside gives you insight into your financial situation. It allows you to make informed financial decisions and be better prepared for unexpected expenses. By having an emergency fund, you can avoid going into debt and reduce financial stress. The peace of mind is priceless.
A lot of people forget that budgeting and setting financial goals is about flexibility rather than rigid control. It’s about making choices and changes and taking advantage of opportunities that interest you.
Contributing to your savings account every time you get paid gives you flexibility as you plan how to achieve your financial goals, such as buying a house, starting a business, or taking a vacation. It gives you a pool of money to draw from if you’re laid off work or have an emergency car repair bill. By contributing to your savings account regularly, you can avoid the stress of having to come up with a large sum of money by the RRSP deadline or when you need a down payment.
How to shift from annual to biweekly savings contributions
If you’re used to making one savings contribution a year, shifting to a biweekly savings schedule will take a little getting used to. It could shrink your paycheques slightly, but it doesn’t have to.
Start by calculating your biweekly savings goal. If you know the annual amount that you’d like to save, divide that amount by 26 biweekly pay periods to determine how much you need to contribute each time you’re paid to come up with the same savings amount. Conversely, if you have set a goal, divide that amount into manageable contributions that coincide with when you receive your income. Once you know how much you want to save, review your budget to see where you can reduce your expenses so that you’re able to meet your new savings goal.
If you want to take advantage of an RRSP matching program, check with your payroll department at work to see what withdrawing your RRSP contributions at source would mean for your net paycheques. By deducting the contribution from your before-tax income, you’ll end up with a little more in your bank account than if you make the contribution yourself from your net income.
You may also want to consider looking for ways to increase your income enough to cover the additional savings contributions without adjusting other parts of your budget. Finally, set up automatic contributions to investment accounts or transfers to your savings account on paydays to make saving as easy as possible for yourself.
The bottom line on prioritizing savings goals in 2024
Rather than waiting to save until you have the money, make this the year where you prioritize saving toward your goals. The RRSP contribution deadline for the 2023 tax year is Feb. 29. This means that contributions made in the first 60 days of 2024 can be used against earned income for either 2023 or 2024. A tax professional can help you determine how best to use your contribution receipts when you file your taxes. Any tax refund you generate could be used to pay down debt or be redirected back into savings. As of Jan. 1, the annual TFSA contribution limit increased to $7,000. Speak with an investment adviser at your bank or credit union to explore which savings options will help you build the wealth you need to realize your financial goals.
Peta Wales is President and CEO of the Credit Counselling Society, a non-profit organization. For more information about managing your money or debt, contact Peta by email, check nomoredebts.org or call 1-888-527-8999.