Our tiny mortgage, which is only $80,000, is about to expire. We can use our approximately $25,000 in available funds to pay off our mortgage, invest, or contribute to our RRSP. What is the best way to go?.
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Considering the tax implications of investments
A $25,000 RRSP contribution will result in a sizable tax deduction for you. Given your respective incomes and tax rates, you should decide if taking that tax deduction would benefit you or your spouse more. RRSP contributions should ideally be made in the name of the spouse with the higher income.
Depending on your income, Linda, it may be best to claim a sizable deduction of $25,000 spread out over two years. Put another way, it could be beneficial to spread out your $25,000 deduction over two years if it moved you into a lower tax bracket this year. In the province of Ontario, for instance, if your taxable income falls between $86,000 and $106,000, your marginal tax bracket for an RRSP tax deduction could be anywhere between $2030 and $2043. If you could defer the deduction and take the entire amount in a tax bracket in 2012 instead of receiving a portion of it at 2031, you would be able to receive a 2012 after-tax return. The contribution would still be made, but you would not be required to deduct it from your income in the year that it is made. It can be carried over to lower your income in a subsequent year by way of a deduction.
It’s not as easy as just comparing your expected return to your mortgage rate when it comes to RRSPs, but in general, you can earn a lower rate of return in an RRSP over time and still come out ahead. An RRSP contribution would be more advantageous than debt repayment if your tax bracket is high, your investment risk tolerance is high, your anticipated retirement income is low, or your time horizon until return is long.
Because you can invest in a TFSA and then access the money for a variety of purposes, such as paying off debt or contributing to an RRSP, TFSAs are a bit of a wild card. Contributing to a TFSA could give you the best of both worlds: the ability to keep your savings accessible and, hopefully, the ability to choose debt repayment or RRSP contribution at a later time when you have more money.
Which should Canadians prioritize: RRSP or mortgage?
Most Canadian working adults have debt, and the majority of them will have money in their tax-free savings accounts (TFSAs) and registered retirement savings plans (RRSPs). To make matters more complicated, some of us also have group plans with matching contributions at work. Ensuring that your cash flow is allocated appropriately is a crucial aspect of financial planning.
I see that you call your mortgage in your situation, Linda, a “small” mortgage. Small can be relative or based on your own perspective. That tells me you’re not that “worried” about it if it feels like a minor debt to you. I agree that it makes less sense to prioritize debt repayment over investing if a person has a modest mortgage in comparison to the value of their home. On the other hand, if you had 2010% equity in your home, I would be more likely to build a little buffer by paying down debt rather than investing it.
Pay Off Mortgage or Invest in RRSP? Which Is Better?
FAQ
Is it better to put money in retirement or pay off mortgage?
What is the disadvantage of a RRSP?
Am I better paying off mortgage or investing?
Should I pay my mortgage or RRSP?
If your retirement is around the corner, pay your mortgage more quickly to reduce your budget for the next few years. Also to be considered, if you are taxed at a high rate, RRSP contributions might be more advantageous than mortgage payments because of the associated tax savings.
Should you invest in an RRSP?
You might find historically low interest rates to be a factor in favour of investing in an RRSP. That’s because paying off a low-rate mortgage doesn’t offer the same level of savings as paying off a higher-rate mortgage. But remember that as rates move up, mortgage savings could take on renewed importance.
Should I contribute to an RRSP and pay down my mortgage?
The best scenario for many people is contributing to an RRSP as well as paying down the mortgage. For example, you could make your RRSP contribution each year, and then pay down a portion of the mortgage principal using the tax refund generated by your RRSP contribution.
How do you pay off a mortgage with an RRSP?
Opt for the variable rate, the lowest on the market, and by making higher payments, you’ll pay off your mortgage more quickly. Each year, use the tax return you get from your RRSP contribution to pay down your mortgage. If you want to contribute to your RRSP but can’t seem to pay off all your credit cards, you need to review your financial plan.