RRSP Contribution vs. Payoff the Mortgage

A critical question facing all homeowners is whether to pay down the mortgage or contribute to the Registered Retirement Savings Plan (RRSP). There is no definitive answer.

Your decision depends primarily on your goals: Retire early and comfortably or pay off debt and save on interest payments?  The more you prepay your mortgage, the more you save in interest and the sooner you own your home.

On the other hand, even if your home appreciates, selling it and moving into a less expensive home is not likely to finance a 30 year retirement.  An RRSP can help support you in retirement, and that increases the importance of making your annual contributions.

There are critical factors that go into making your decision – your mortgage rate, the expected rate of return on RRSP investments, the tax savings on RRSP contributions, and the increased cash flow generated if your mortgage is discharged early (although there could be costs associated with this).

So, let’s say your RRSP can average a five to eight per cent return over the next ten to 20 years and your mortgage interest rate runs around six per cent.  In this case, the RRSP returns outweigh the benefits of paying down the mortgage.  Add to that the tax refunds from your RRSP contributions than can be applied to your mortgage.

If your focus is to lower debt, paying down your mortgage, particularly in the early years, can save you thousands of dollars over the life of the mortgage.

Here is a list of some of the considerations when you confront the mortgage versus RRSP dilemma:

Age – As retirement nears, you total assets become increasingly important so prepaying your mortgage may be more attractive.  That way, you own your home and have no mortgage payments in retirement.  When you are younger, an RRSP may be more important, because the sooner you put money into the plan the longer it can grow.

Income – Higher income means higher taxes so you need to earn more after-tax dollars to pay down your mortgage.  At that point, the tax savings from RRSP contributions can be more valuable.

Rate of Return – If you have a good track record on investment rates of return, you may want to opt for RRSP contributions rather than focusing on the mortgage.

Mortgage Rate – If your mortgage rate is relatively low, investing in an RRSP can give you a rate of return that outweighs the interest payments.  When mortgage rates increase, the picture can change and you may want to accelerate mortgage payments to save interest.

Financial Health – If you think you will need access to ready cash in the future because of health, employment or other concerns, the money you put into an RRSP could be more readily accessible than home equity.

You might be able to get the best of both worlds: By investing in an RRSP and using a tax refund to pay down your mortgage, you can essentially diversify your investments, reduce risk and increase your earning potential.

A final factor: The tax advantages of a RRSP last a lifetime while the advantages of a mortgage prepayment end when the mortgage is discharged.  Think carefully before you make your decision and consult your tax adviser.

In summary the deciding factors are:

Consider mortgage pay downs when your circumstances include:

  • Unstable employment.
  • Low tax bracket.
  • Near retirement.
  • High mortgage rate.
  • Long amortization.

Consider an RRSP contribution when your circumstances include:

  • Stable employment.
  • High tax bracket.
  • Relatively young age.
  • Low mortgage rate.
  • Short amortization.

If you should any questions with respect to the above, please do not hesitate in calling me at 905-528-0234 or email Joe at joetruscott@josephtruscott.com.