In this article, we share some considerations regarding this common dilemma to help you decide which option is better for you: investing for retirement or paying down your mortgage.
Contributing to an RRSP and paying off your mortgage are choices that can seem equally important. After all, both address really important aspects of your financial life: your retirement and your estate. The right answer for will depend on your individual circumstances. Let’s take a look at each of these options.
Contributing to your RRSP
Contributing to an RRSP can have both short-term and long-term benefits. Contributions to an RRSP are made on a pre-tax basis, offering a tax benefit in the year the money is contributed. The maximum contribution to a RRSP for 2022 is 18% of your earned income, up to a maximum of $29,210. Any unused portion (also known as contribution room) of this limit can be carried forward to a subsequent year.
Additionally, money invested in an RRSP grows on a tax-deferred basis until withdrawn. Investment options typically include mutual funds, guaranteed investment certificates (GICs), ETFs plus individual stocks and bonds.
Besides the tax benefit of pre-tax contributions to an RRSP, the benefit of compound tax-deferred growth within the account may be the biggest benefit of investing in an RRSP.
Paying off your mortgage
Paying off your mortgage can eliminate one of the biggest monthly expenses in a homeowner’s budget. The issue for most people is where will the money to pay off the mortgage come from?
One strategy is to pay an extra amount towards your mortgage on a monthly basis. This will add to the amount of principal that you are paying down each month. Depending on your mortgage balance and the interest rate, this can help you pay off your mortgage several years earlier than if you made only the required payments each month.
Certainly if your mortgage carries a high interest rate it can make sense to pay it off as quickly as possible.
Issue to consider
Age. One issue to consider is your age. If you are older and closing in on retirement, then working to pay off your mortgage early can make sense. It can be very helpful to your retirement budget to eliminate this monthly payment from your budget prior to retiring.
For someone who is younger, it is often better to focus on maximizing contributions to your RRSP as the tax-deferred growth can then accumulate a large sum for retirement. While the returns will depend upon how you allocate your funds among various investments, the power of tax-deferred compounding of investment returns over time can be incredible.
Rates. When weighing an RRSP contribution versus a mortgage paydown, a huge consideration is also the rate you are paying on your mortgage versus the anticipated rate of return on savings in your RRSP. If your mortgage is locked in at 2.5% and you can get a higher rate of investment, an RRSP may be the route to go.
While it is always better to start contributing as much as possible as soon as possible, the power of compounding can still be a major advantage for workers further along in their careers.
Tax liability. Additionally, contributing to an RRSP offers an excellent tax break each year. This tax benefit can be the single largest tax break many people receive each year.
Liquidity. Another consideration is that money tied up inside of a home that is fully paid off is largely illiquid. While you could take out a home equity loan if needed to tap into some of that equity, this puts you right back in the same position as you were before with having a mortgage payment.
Why not do both?
Perhaps the best strategy is to do both.
Contribute as much as you can to your RRSP to take advantage of the opportunity for tax-deferred investment growth over the longer term. In an RRSP, if invested properly, your investments can help you build a solid nest egg for retirement. In the process, look at your monthly budget and determine if there is an amount that you can put towards paying down the mortgage balance each month.
Everyone’s situation is different of course. A good approach to this situation is to look at your monthly cash flow and determine how much you can contribute to your RRSP and how much you can comfortably allocate towards paying down your mortgage more quickly.
An alternative is to determine how much you are saving in taxes from making your pre-tax contributions to the RRSP and allocate some or all of that money towards paying down your mortgage balance early.
A major consideration here is what the interest rate on your mortgage is versus your expected return on your RRSP investments. For most people the RRSP return over time will likely be higher, but not in all cases.
Conclusion
The decision as to whether to focus on saving in an RRSP or paying down your mortgage will vary among people based on their unique circumstances. Talk with one of our advisors to develop a strategy that makes the most sense based on your situation and your goals.
Give us a call at 514-934-0586 (Montreal) or 403-228-2378 (Calgary) to discuss ways to put your tax refund to use and to do a review of your tax withholding to ensure that it is optimal for your situation.
While this article been carefully checked, we cannot and do not guarantee that the information provided is correct, accurate or current. Please speak to your Rothenberg Wealth Management advisor for advice based on your unique circumstances. Rothenberg Capital Management is a member of IIROC and the Canadian Investor Protection Fund.
