Homeowner, Savings & Investments, Tips & Advice

Should You Get an RRSP or Pay Down Your Mortgage?

The deadline for contributing to your RRSP is fast approaching but you still haven’t gotten one.

Not because you don’t have the money – you’ve managed to put aside some funds – but because you don’t know what to do with the money. All you know for sure is that you can’t afford to do both.

Sure, everyone says that contributing to an RRSP is a good thing but what about that mortgage you’re still paying every month? Wouldn’t you be better off if you made a lump sum payment on that?

It’s that old February dilemma again;  RRSP contribution versus mortgage payment? Which is best?

The Simple Solution

The simplest way to decide is to look at two things; the interest rate on your mortgage and the return rate of your planned RRSP investment. Generally, if your mortgage interest rate is equal to or higher than the rate of return on your RRSP, you would be better off paying down the mortgage.

So, for instance, if your mortgage interest rate is 5% and you plan to put your RRSP contribution in to a GIC which pays 2.5% interest, the quick and easy answer is that you would be better off paying down your mortgage.

A More Detailed Analysis

However, this is a very rough guide. If you make a more detailed analysis of the potential financial benefits of each option, the answer may be different.

Let’s suppose again that your mortgage interest rate is 5%. It’s actually not just a matter of paying down the mortgage and getting the financial benefit of not having to pay that 5% interest in the future; it’s a matter of how much it costs to pay down a dollar of debt, which is always more than a dollar. So if it costs $1.50 to pay down a dollar of debt, the financial benefit of paying down your 5% mortgage would be 7.3%.

The financial benefit of the RRSP contribution, on the other hand, depends on your marginal tax rate. In our tax system, taxpayers pay tax on their income based on their earnings so that taxpayers who earn less are taxed at a lower rate.

So depending on what province you reside in and what tax bracket you’re in, your RRSP contribution could give you a tax savings of anywhere from 25 to 48%. That’s a whole lot better than 7.3%, isn’t it?

You Can Do Both

Still having trouble sleeping at night because of your mortgage debt? Then why not do both?

Make an RRSP contribution to get those great tax savings (and tax-deferred compounding working for you!) and then use your tax refund to pay down your mortgage.

TurboTax’s RRSP Optimizer lets you see exactly how much income tax would be due or how much of a refund you would get depending on how much of an RRSP contribution you make.

Using money you’ve saved to save even more money. Now that’s a smart decision.