Which is better, contributing to your RRSP or paying down your mortgage? The RRSP-versus-mortgage question is a source of ongoing debate among many investors and financial professionals. The question is complex, and there is no definitive answer. The challenge is to determine what is more appropriate for you, given your current situation and long-term goals.
Three possible options are:
Option 1: Pay off your mortgage first and then contribute to an RRSP. With this strategy, you get a guaranteed after-tax return through your mortgage interest savings, which is important to many conservative investors.
Option 2: Contribute to an RRSP and use tax refunds to pay down the mortgage. When various personal situations are assessed, many investors decide to build two types of assets -- home equity and RRSP savings. Here you achieve mortgage interest savings by paying off your mortgage earlier and building a retirement savings base. This also provides further diversification of your investment strategy.
Option 3: Contribute to an RRSP and use tax refunds to contribute more to your RRSP. This strategy maximizes long-term tax-free compounding of RRSP assets, and gives the psychological benefit of knowing you are building a capital base to fund your retirement. Should you decide to stay in your home during retirement, it's the RRSP capital base that will help give you financial security.
The major factors influencing the choice of options are the mortgage interest rate versus the expected return in the RRSP, the investment time horizon, the availability of RRSP contribution room, and the ability to capitalize on mortgage prepayment privileges.
Given an expected RRSP return equal to the mortgage interest rate, and an investment time horizon of over 30 years, maximizing RRSP contributions generally maximizes net worth because the tax-sheltering advantages of the RRSP last for a lifetime, while the advantages of the mortgage prepayment end when the mortgage is discharged.
As the mortgage interest increases, or the investment time horizon decreases, it becomes more attractive to prepay the mortgage.
However, the answer comes back to your investment objectives and what is most appropriate for your personal circumstances. The best step to take is to assess each of the options available to you and decide which fits best with your current situation, risk tolerance, and goals for the future.
For a complimentary copy of our Retirement Savings Guide, contact my office.
Daniel Saikaley, CA CFP EPC - Investment Advisor, CIBC Wood Gundy
50 O'Connor St., Suite 800, Ottawa ON K1P 6L2 - Ph. 613.783.4674
email:daniel.saikaley@cibc.ca. Also, visit my website: www.danielsaikaley.com and click on This Month's Featured Solution.
The information contained herein is considered accurate at the time of printing. CIBC and CIBC World Markets Inc. reserve the right to change any of it without prior notice. It is for general information purposes only. Clients are advised to seek advice regarding their particular circumstances from their personal tax advisor. In addition, legislation in this area is continually changing. Before taking any action, you should seek legal advice to ensure that your planning is appropriate to your personal circumstances and that it is effective in the jurisdiction in which you reside.
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