What to do with Xmas Bonus?

by Mike Holman

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I get a year end bonus which normally adds about 10% to my annual salary. It’s a bit early to be thinking about what to do with it but I’d thought I’d write a post since I can’t decide. Basically the choices are to put it into my rrsp or my mortgage or split it up and do both.

Up to now this money has always gone in to the mortgage and in some cases paid for vacation trips.

This year I’d like to only use it for mortgage and/or rrsp and nothing else. Since I feel my mortgage is excessive and I worry about it a lot more than the size of my rrsp, it seems like a no brainer to put the money into the mortgage. However at the same time if I put it into the mortgage then that means I’m paying a lot of tax (43.38% to be exact) on it, which I can defer if I put it into the rrsp.

One of the strategies I was thinking about was to see how the markets perform this year and perhaps decide based on that. For example if my rrsp (I’ll use my portfolio as the index) does better than say 5% then I’ll put all the money into the mortgage – I’m thinking that considering how well the markets have done, if they continue to do well then maybe they should be avoided. Bernstein says to buy when things are looking their worst – not at their best. On the other hand if the rrsp goes down at least 5% this year then I’ll put the whole bonus into the rrsp. If the return is between -5% and +5% then I’ll figure out some ratio and split the bonus between the mortgage and rrsp.

A couple of other things – even without the bonus we make quite a bit of extra mortgage payments. We also contribute a fair bit to the rrsp on a normal basis . Regardless of the my choice, neither the rrsp or mortgage will be ignored!

Any opinions?

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{ 13 comments… read them below or add one }

1 moneygardener

Yes, the age old question….

Here’s a thought. Put all of it into your RRSP. Then in April when you get money back in the form a a refund from revenue Canada, put that towards your mortgage.

2 FourPillars

MG – The bonus won’t have any tax deducted so there won’t be any refund.

Mike

3 moneygardener

???

I am reffering to the money you get back from revenue Canada at year end for lowering your taxable income and hence paying too much tax over the year. Not specifically the portion attributable to your bonus tax.

4 TheFinancialBlogger

FP, when you put money into your RRSP, you might want to consider the power of compounded interest instead of thinking about 1 year yield. You are not going to withdraw from your RRSP for a while. Therefore, you should calculate what your RRSP contribution would be at the time of withdrawal VS interest charged over the next 20-25 years on the same amount (if you let your mortgage as is).

I can appreciate that putting money down on your mortgage makes you sleep at night as it represents a big debt. However, all these RRSP contribution will surely represents more money in 20 years than the value of your mortgage plus interest.

On my side, I used my RRSP contribution to buy a 42″ Plasma TV and it worth every penny! But I usually max my RRSP and then, invest the difference in non-registered funds.

Cheers,
FB

5 FourPillars

MG – at my company, if I make rrsp contributions into the group rrsp they will not hold back any taxes so for example if I tell them to contribute $500 per month – that money will be coming out of my gross pay and no taxes are paid on that money.

Alternatively there is a form you can fill out and send to the government once a year which will lower your withholding taxes for money you are planning to contribute to your rrsp. Either way this is a better way to contribute to your rrsp assuming you are doing regular contributions.

I’ll do a post on this for tomorrow.

Mike

6 FourPillars

FB – you are an inspiration to us all! A 42″ plasma would be awesome – maybe I’ll add it to the list of options??

Mike

7 Canadian Capitalist

If you are worried about your mortgage, it’s a no brainer. Pay it down. Peace of mind is worth more than a potential few extra percentage points in return.

8 moneygardener

FP,

My company plan works the same way.

I guess you are saying that you will not receive a refund from rev. Can for overpaying tax on your regular salary vs. your regular RRSP contribution.

9 FourPillars

CC – can’t argue with your logic. I suspect that’s what I will end up doing.

MG – I’m not sure what you mean. In the case of our bonus we can elect to receive the entire bonus as regular pay or put all or part of it into the rrsp and they will reduce our tax deduction accordingly.

Mike

10 pk

Here is another idea, which may or may not work in your case. It all depends on when your bonus is actually paid out. If you get it after Jan 1, 2008 and tax is not withheld at source when you direct it straight to RRSP, what you can do is to claim it for 2007 and get tax refund for 2007 at your marginal tax rate, while this bonus will be actually included in your 2008 income! What you’re doing you’re effectively postponing paying of the tax on this amount for one year while still getting full amount working for you inside RRSP. I’ve done it for a couple of years with my bonuses and while I have a tax liability I also keep that tax in my investments working for me! You need to be able to pay this tax or eliminate it through some deduction at one point, so keep this in mind.
If you have a HELOC you can put the tax refund into your HELOC and it will save you interest you’re paying for one year. When you have to pay tax you’ll withdraw it if needed. If you get another bonus next year do the same thing and save more on interest charges….

11 FourPillars

Thanks for the comment PK.

Mike

12 PK

:) I guess you like my idea didn’t you? I am a strong believer that the longer you can postpone paying taxes while making money work for you the better. I apply this wherever I can. That’s why I don’t rush much with paying off my mortgage, especially with interest rates around 5%. I instead I maximize my RRSP and use leveraged investments. What I’ve been doing with RRSPs is to put every year as much as possible by borrowing to eliminate the actual tax refunds. I basically pay off my short term loans I take for RRSP top ups with our refunds. Some people pay down their mortgages with tax refunds, I basically put it back in RRSPs…

13 FourPillars

PK – Of course I like your idea. The great thing about a blog is getting other ideas from other people.

I agree that deferring tax even for a short time is a good practice. Most people get upset when they owe money at tax time but they are really coming out ahead (unless they can’t come up with the money).

Mike

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