RRSP Contribution Or Mortgage Pay Down?
One question I was often asked when I worked in banking was, “Should I pay down my mortgage or maximize my RRSP contributions?”
Being a good employee concerned with the (you know who’s) bottom line, the simple answer was usually, “Maximize your RRSP contribution, then use your (considerable) tax refund to make a lump sum mortgage payment.”
Related: How I Plan To Be Financially Free By 40
You’ve heard this many times before.
What if you wanted a more detailed answer from your banker?
Maybe you’ve had the same experience as this couple:
Banker (reaching for his calculator): Okay, say you put $5,000 down on your mortgage and keep the payment the same, you will reduce your balance and pay it off in about 11 years. Then if you make the same payment to your RRSP, at a rate of 5%, in 2 years you will have $23,966, but this is before tax. Let’s say you’re in the 40% tax bracket, you’ll have $14,380. But this ignores the tax refund, which you could also invest which would amount to $39,920 or $23,592 after tax. Now on the other hand, if you contribute the $5,000 to your RRSP today you will accumulate.., blah, blah, blah….
Eyes glazed after hearing too much detail, the couple leaves the bank, still not knowing which strategy to use.
Related: Can You Trust Advice From Your Bank?
If you were to ask me that question today, the answer would be – it depends.
You could consider how the rate of return on your investments, interest rate on your debt, tax rates and time horizon can impact your decision.
But, instead of doing mathematical gymnastics and trying to predict the future, consider these suggestions:
When you should pay down your mortgage – or other debt
It makes no financial sense to pay 18 – 29.9% interest on credit card balances. Pay these down first, then any loans and lines of credit you may have, then your mortgage.
If you have a large mortgage payment that could become onerous if the interest rate increases on renewal, pay extra on your mortgage. On a $400,000 mortgage, after 5 years, the monthly payment will increase almost $200 if the interest rate rises by 1%, and about $350 if the rate goes up 2%. Paying extra could smooth out your payments down the road.
Related: How To Pay Off Your Mortgage Faster
If you are over 50 years old, pay down your mortgage. If you are still in debt when you retire, you will be paying out valuable resources that could be used for a better quality of life, instead. Also, if you want to downsize in the future, or participate in a reverse mortgage plan, you’ll have more equity in your home to work with.
Contribute to your RRSP
If your mortgage balance is moderate and/or you are paying an exceedingly low interest rate, put the money into your RRSP.
People who are not enrolled in any type of employer-sponsored pension plan or group RRSP will probably find themselves in a significantly lower tax bracket on retirement. Funding the RRSP, as much and as early as possible, can make a big difference in income.
If you earn a high salary and an RRSP contribution will bring your taxable income down to a lower tax bracket, you should take advantage and receive the larger tax refund.
Conclusion
Psychologically, paying down debt just feels right. On the other hand, contributions to an RRSP benefit from compounding and tax deferment, as well as giving you access to cash in the event you lose your employment income (which keeps you from losing your house).
Related: How Much Of Your Income Should You Save?
In any event, whether you have a lump sum amount, or an extra couple of hundred dollars a month to work with, you are still ultimately saving for the future with either approach.
And you can still make a lump sum mortgage payment with your tax refund.
Marie, outstanding post. Just outstanding. Bonus points for slipping in a nice “it depends” in there too 🙂
@Sandi: Thanks for your support.
I’d suggest doing both. I always could accomplish this and I did not make big money. I did not carry credit card debt, nor did I go on vacations. I lived within my means and my children learned the value of a dollar. All of them worked through their teen years in order to get money for their own “extras”. We had plenty of food and lived in a nice house. The rest does not matter. I was divorced while the children were small and they grew up watching me balance the budget and writing in my notebook where I kept track of every dime. I also saved for new appliances, new car, new clothing, and Christmas and birthdays. The amounts were small, but they were there, and small amounts add up over a year. And we did alright.
@Hannah: That’s the way to do it. Unfortunately, there are a lot of folks out there who just don’t have the same handle on their finances as you apparently do. You don’t want to ignore RRSP savings to focus on quick house repayment and, as you say, there are a lot of other demands on your dollar. Good job.
This post is why your forum is required reading by our kids (39 & 41)!!!
@Gary: Thanks Gary for your kind words.
I suggest doing both by making RRSP contributions and then putting the income tax refund against the mortgage.
I wish people wouldn’t worry so much about doing the “right” thing. I doubt there’s any one correct answer. If they pay the mortgage or invest in their RRSPs they are doing the right thing. Either one will help them immensely in the future.
Agreed Bet. Paralysis by analysis
Every week I pay off the credit card (where we charge everything), make sure the pay is in, then assess how much excess is in the account. Every week the excess is transferred out to either our RRSPs or we make an extra mortgage payment. The sooner the money is moved the sooner we benefit. If the markets are having a sale we take advantage and send the funds to our RRSPs. If the markets are sky high we make an extra mortgage payment that week. We know the total amounts we want sent to both each year, we just juggle which contribution makes the most sense each week.
@Blaze: Sounds like you’ve made a plan that works well for you. Well done!
I’m always in favour of paying down your mortgage before you do just about anything else. Of course you need to ensure that you have an emergency fund, are paying down your debt, and making some sort of RRSP contribution. But don’t put all your cash into an RRSP while your mortgage debt just sits there. If you have extra cash and you don’t know what to do with it, kill two birds with one stone by paying down debt, and lowering your mortgage payments at the same time. Just be sure you won’t be penalized by your lender for doing so.
I’d say it’s about the right balance between both.However as for me, I would probably pay off my mortgage using a major chunk of the money and contribute the rest to my RRSP.