RRSP Snowball Effect?

In this article by Dereck Slattery he offers a few RRSP tips. His 2 tips basically boil down to 1) don’t contribute at the last minute, instead take some time and make a “good” investment and 2) apply your refund to your RRSPs for the following year.

He goes on and on about this second point as if it’s some magical thing and there are so many assumptions built into his advice. Here’s the entire section:

Make it a habit to re-invest your tax refund back into your RRSP over and above what you put into the RRSP on a regular basis.

The benefit of this is as follows. Let’s assume that you invest $200 per month into your RRSP and normally you receive $1,000 in refund when you file your taxes. If this year you were to re-invest your refund into your RRSP when you receive it, you will have contributed $3,400 to your RRSP for next year.

All things being equal, in a 40 per cent tax bracket, your refund should increase to about $1,400 next year.

You can see where I am going with this – you contribute the same amount out of your pocket each year, your refund grows each year because you have put your refund into the RRSP each year and the snowball effect begins.

Bit by bit, your total amount invested into the RRSP each year climbs and your refund gets a bit higher each year, adding greatly to the value of the RRSP as each year passes.

First of all, this is hardly a “snowball effect.” Using the numbers above, you normally get a refund of $1000 and after contributing that amount into your RRSP, your refund the following year is $1360 (he approximated it by $1400). If you contribute that $1360 refund into your RRSP, your refund the following year will be $1504. Contribute and deduct the $1504, and you’ll receive a $1562 refund. Contribute and deduct the $1562 and you’ll receive $1585. Actually if you keep doing this forever you’ll increase your refund to $1600 and it won’t increase anymore. Hardly what I would call a “snowball.” So by following his little technique we have increased our refund to $1600 from what would normally be a refund of $1400. He puts way too much emphasis on this “snowball effect” and misses the real point that he should be trying to get across, which is: contribute as much as possible to your RRSP. If your refund helps you to do this, then that’s great.

For those people who already maximize their RRSP contribution room with their monthly contributions, the “snowball effect” won’t apply to them anyways. You won’t be able to use your RRSP refund for your RRPSs because you are already maxing-out your RRSP room with your monthly contributions.