Mortgage or RRSP?

One of the personal tax questions I get asked most frequently is whether to put money into RRSP’s or pay down a mortgage. 

Great question – and one that has meaning for almost every Canadian.

I hear from lots of people that they used to ‘do’ RRSP’s but the market has been so bad in the last 5 years or so that they don’t even bother any more.  They just don’t see the point.  Some have even told me that they keep putting money in there every month and the balance just keeps going down!

There are a couple of things to consider when thinking about investing in RRSP’s.  Obviously the first thing that presents itself is the tax advantage.  If you are in the 30% tax bracket  and you invest $10,000 you will obviously get a refund of $3,000.  Money that you can use to take a trip, buy that new 80” TV, invest or whatever you like.  When you withdraw the money when in retirement you will have to pay tax on it.  One of the basic ideas of RRSP’s is that there will be a deferral of tax, but hopefully when you retire you will be in a lower tax bracket.  This would result in a permanent tax reduction.  For instance if you are in a 20% tax bracket when you retire you will pay $2,000 in tax on that same $10,000 resulting in a permanent $1,000, or 10%, tax savings.

This is all great, but the reason for investing at all is to make a return on your invested funds – or at least to not compromise the principal.  All too often these investment goals are not being realized.  This may not be due to the RRSP vehicle itself, but due to the investments chosen inside the RRSP. 

When most people think about RRSP’s they think about Mutual Funds and GIC’s, but can own almost any kind of investment in an RRSP.  Mutual funds may or may not be the right vehicle for you.   It’s not unusual these days to see a Canadian mutual report a 10 year return of between 4 and 5%, subtract the MER’s (expenses) you’re left with 2 or 2.5% – not great given that the 10 year inflation rate average in Canada is 1.8% (so you’re left with less than 1% real growth!).  With a little bit of work you can find a 5-Year GIC at 2.35% – presumably with little or no risk to your original investment – that can be a little disheartening.

Now, some mutual funds are much better than others, but they can be harder to find.  You are not limited to mutual funds.  Equity stocks, bonds and ETF’s (Exchange Traded Funds) are tools that also work very well, but may not be suitable for an amateur investor.  You need help – a professional advisor who can sell more than just mutual funds and GIC’s and certainly more than just the mutual funds that their company runs.

So my two pieces of investment advice are: don’t settle for mediocre returns and get a good, professional, trusted investment advisor. 

Alright – if you can get a tax refund and a decent return in your RRSP (say 8-10%) and it’s meeting your tax and investment goals what’s the point of talking about paying down the mortgage?  It depends on where you are in your life and what your goals are.  Most people have a strong aversion to being retired and having a mortgage.  So if you find yourself, for whatever reason, being 45 and having 25 years left on your mortgage, then perhaps putting $10,000 on your mortgage is more in line with your goals.  This will reduce your amortization period by more than 13 months and reduce your interest costs by over $16,000 at today’s prevailing rates.

So there is a time and place where each answer could be correct depending on where you are in your life and what your goals are.  Part of the holistic approach to financial management is having the experts on your team to help you define your goals – and get there.

My favourite answer to this question is – both!  Put the $10,000 in your RRSP and then use the refund to pay down your mortgage – that’s leveraging the tools that are available to you!