When you’re younger and still paying out your first house should you also be
investing in RRSP’s and saving for your retirement? Well, that’s up to you. In
some instances it could be more beneficial to forget contributing to RRSP's
altogether and focus on paying down your mortgage.
Banks win twice when you focus on both your mortgage and your RRSP’s. They get fees from selling you
mutual funds in your RRSP and they keep you in your mortgage longer (paying
mortgage interest charges). That’s why
their traditional advice is to put as much money in your RRSP as possible and
then use your tax refund to pay down your mortgage. This is a good approach. But
it may not be optimal. RRSP’s have no significant tax advantage over mortgage
payments.
It’s like a tax shelter because you’re working with after tax dollars and
putting/keeping future money in your pocket. Ever time you make a mortgage
payment you reduce your principal and therefore pay less interest over the life
of the mortgage. All of the future interest payments that you no longer have to
make would have been made in after tax dollars, so you not only save the
interest but the tax on that interest too. The net effect is really a tax-free
return on the money you use to pay down your mortgage, just like the tax free
return on your RRSP.
There is no risk because you don’t really get a better return from RRSP’s than
from paying down your mortgage. Compare a 6% mortgage rate to an 8% return on
your RRSP. The 8% looks better. But the 8% return on the RRSP is not a sure
thing while the 6% return on your mortgage is a sure thing. And the average
mutual fund in Canada charges over 2% in fees, so the actual return you could
expect from an RRSP after fees is about 6%.
The pitfall of this approach is that you will neglect to save for retirement. If
you stick to the plan, pay off your mortgage and then concentrate on RRSP
contributions you’ll have additional free income for retirement savings. But if
you turn around and buy a bigger house, get back into the mortgage game again, you
don’t win. So, think about it.
