Many of you ask yourselves if it’s better to pay down your mortgage or use the extra funds to contribute to your retirement fund (RRSP – Registered Retirement Savings Plan)
The simplest answer is: It depends!
It depends on many factors such as:
- the interest rate you are paying on your mortgage versus the return you are earning in your retirement account
- the amount you have already accumulated in your RRSP account
- the remaining term on your mortgage
- your marginal tax rate
- your personal priorities
Let’s tackle some of these factors and hopefully help you make an informed decision.
The option of paying down your mortgage makes the most sense:
- If you are in a low tax bracket. This is due to the fact that you won’t be receiving a significant tax refund by contributing to your RRSPs.
- When your mortgage interest rate is equal or higher than the rate of return on your RRSP. For example, if your mortgage rate is fixed at 5%, but your RRSP portfolio is only earning 4%, then of course you are better off paying down your mortgage. Plus the savings from paying down your mortgage are guaranteed, whereas the rate you are earning on your RRSPs is not! (To find out the rate of return on your RRSP, check your last statement… make sure to look for the annual return, not just last quarter’s return!)
- If you are close to retirement but still have an outstanding mortgage. Your goal should always be to retire debt-free. So if you are approaching retirement and still have a mortgage, paying down your mortgage is a better option, because your new RRSP investments will not have enough time to grow anyway.
The option of contributing to your RRSPs makes the most sense:
- If you are in a high tax bracket. This will provide you with a significant tax refund which you can in turn use to pay down your mortgage. The best of both worlds !
- If your mortgage rate is very low, which could very well be the case these days since we are seeing historically low interest rates.
- If you have only a few years left on your mortgage. You have already paid the largest chunk of the interest due to the bank, so paying down the mortgage will not save you so much interest. Towards the end of your mortgage ‘s lifetime, the largest portion of your monthly payment is composed of principal payment, rather than interest expense.
- If you are lagging behind in your RRSP account. How do you know if you’re behind? Look for your Unused Contribution Room amount on your last federal Notice of Assessment versus the amount you have already in your RRSP account. Is there a substantial discrepancy between these 2 numbers? Then you know that you are lagging behind and you should contribute your additional funds to your RRSP and get them to compound tax free.
Last but not least, the choice between mortgage and RRSP depends on your personal priorities, as well as your own risk aversion. If you are the kind of person who absolutely hates having debt, then you will have peace of mind knowing that you’re paying off your mortgage as fast as you can. This is also the case if you are very risk averse and cannot stand seeing your RRSP portfolio lose value during shaky market periods.
However, if you are on the other end of the spectrum, and you won’t lose a minute of sleep over your RRSP portfolio going down, then contributing to your RRSPs will financially satisfy you more than paying down your mortgage.
So next time you have some extra funds and you’re unsure about using them for your RRSP or your mortgage, you can analyse your situation and see which factors apply to you. My goal is for you to make the smartest financial decision!
Feel free to check out this calculator to help you with your decision: http://www.empire.ca/consumer/forms-and-tools/rrsp-vs-mortgage-calculator/en/