Part 2, of the great debate… With RRSPs at the forefront of everyone’s minds I want to continue to share with you comments on the most common debate. In Part 1, we talked about three questions you should ask yourself, below we will show how you might be able to contribute to your RRSP and put a little extra down on your Mortgage.
Should I pay down the mortgage or contribute to the RRSP?
Generally speaking, either financial strategy is a good choice. It is better than spending the money on things that have no inherent financial value. It is also better than “investing” (I use that term loosely) in depreciable assets like cars. Let’s compare the financial benefit of the two alternatives. First, let’s look at your mortgage. We know that mortgage rates are around 2.7%. You might think that paying down the mortgage means you forego paying 2.7% in the future, and therefore, the mortgage pay-down has a financial benefit of 2.7%. Most mortgages are not tax-deductible thus you must earn more than a dollar to pay down a dollar of debt. In fact, you probably need to earn about $1.23 to pay down a dollar of debt (depending on your tax bracket – Middle income is about 23%). Therefore, paying off your mortgage has an after-tax benefit of over 2.7%. Remember, the higher the interest rate on the mortgage, the more attractive it is to pay down the mortgage.
Now let’s look at the RRSP. If you are in the middle marginal tax bracket, you will save around 23% in tax (combined federal and provincial; note: rates vary from province to province). In a higher tax bracket, an RRSP contribution might save you as much as 46% in tax savings. The bottom line is that when you compare the two scenarios, a dollar put toward the mortgage saves you 2.7% in interest while a contibution to your RRSP could save you 23% in tax (as discussed 23% is around the middle-income tax bracket). Given the choice, you would likely take a 23% saving over a 2.7% saving. The final point in favor of making an RRSP contribution is that making the RRSP contribution may give you the opportunity to invest in your RRSPs and pay down the mortgage. For example, let’s assume you have $10,000 and you are in a 23% marginal tax bracket. By contributing to the RRSP, you could save $2,300 in taxes and potentially get that in a refund. Once you get the refund, you can then take the $2,300 and pay that down on the mortgage. You have created $12,300 out of $10,000, $10,000 went into your RRSP and because of that contribution, the government potentially refunded you $2,300, which you then put towards the Mortgage.
Generally speaking, anytime, you can pay down a big debt it is beneficial to your overall financial security. The ability to invest in yourself and pay down the mortgage if done correctly creates financial success.
Reality tells us that this is not a debate but sound advice… we are in control of our own situation – sometimes using your rebate to pay for a vacation seems like a better option. The choice is yours make (and you deserve it), but you only have one opportunity per year to double dip between your investments and debt reduction. The choice is yours!
Note: Please be advised that the percentages used in this article are for ease of calculations to help you understand the concept and are not meant to be everyone’s valuation each person’s situation is different.