Student loans or RRSP?

Should I pay off my Student loans or contribute to an RRSP?

This is a common question, particularly if you’re carrying debt and aren’t satisfied with your current savings strategy.  The answer to this question is very individual depending on things like cash flow, interest rates and savings goals.

What you need to know in order to create a debt repayment and savings strategy:

1-   Do you have a functional household budget - are you in the black every month?

2-   What are the limits vs. balances of your debt – ideally no more than 40% balance to limit

3-   Do you have good debt (tax deductible interest) vs. bad debt (non tax-deductible interest)?

4-   Does your place of work offer programs such as savings matching, pensions, etc.

5-   Do you have any major expenses coming up: car purchase, holidays, renos, etc.

Once you have created a budget and determined how much extra you are able or willing to put aside to work towards your financial goals, then you can prioritize those goals and start making contributions towards them.

A note about Student Loans: The interest on student loans is tax deductible, so this type of debt should be low on the totem pole for repayment, meaning you should prioritize any other interest-bearing debt balances. If you were to consolidate your loan into another form of debt (line of credit or consolidation loan) you would lose those tax benefits. If you are otherwise debt free, it would be wise to look at your financial goals and determine what major expenses you would also like to work towards before paying down this debt.

Overall debt repayment is very circumstantial, and you will want to work through the prioritized list to determine what mix of debt and savings strategy works for your budget and goals.

The following chart shows an example where someone has the choice to put $1,200 a year ($100 a month) towards extra student loan payments to pay off debt more quickly, or invest the extra money into an RRSP. We assume that the student loan has an interest rate of 5% while money in the RRSP also grows at 5% per year. Any tax refunds from the RRSP or deductible interest of the student loans are assumed to also be reinvested or used to pay down debt more quickly.

What we can see is that your net worth (what you own minus what you owe) is roughly the same for each option for the first 5 years. In years 6 and 7 the RRSP starts to gain ground, ending with a final net worth about $2,500 more than prepaying the student loan. Given the difference isn’t massive over 7 years, keep all of the earlier considerations in mind when making your decision. And if you’re really stuck on what to do, why not go half and half to each option instead of putting all your eggs in one basket.