You've probably wondered whether it is smarter to invest money in your RRSP , TFSA or pay down your mortgage.This is probably one of the most commonly asked personal finance questions in Canada. The answer depends on many things, including what you expect to earn on your RRSP or TFSA and the terms of your mortgage.
Either way you’re investing in your future. Paying down your mortgage helps reduce future interest costs, and builds home equity. Contributing to your RRSP or TFSA builds your savings through the power of tax-free compounding.
What solution is right for you … or should you do both? Let’s take a look at both sides of the equation.
Pay down your mortgage
Being mortgage-free as soon as possible may be a sound strategy for creating wealth. Contributing to your mortgage over and above your payment will help you be mortgage-free sooner. Any additional amount over your regular payment will go directly towards reducing the principal. The more you pay down now, the more interest costs you’ll save in the future.
If your mortgage interest rate is equal to or higher than the rate of return you expect to earn on your RRSP or TFSA, then reducing your mortgage can be a good choice. An important thing to recognize is that when you pay down your mortgage it guarantees you a rate of return equal to the mortgage rate. In this low interest rate environment, it’s not possible to earn a similar guaranteed rate in your RRSP or TFSA.
Saving through RRSP/TFSA contributions
Money invested in your RRSP compounds tax-free, earnings on TFSA contributions are tax exempt. In either case each can create a sizeable nest egg for you in retirement. Also, if you're not planning on retiring for a while, the compound interest you can earn is likely more advantageous than a paid-off mortgage.
If the expected rate of return in your RRSP or TFSA is higher than the interest rate on your mortgage, then contributing to an RRSP or TFSA makes sense, (eg. 9% in your RRSP vs. 3.99% on a mortgage). It’s important to recognize however that the rate of investment return is not guaranteed and higher returns come with a higher risk.
Another consideration is to do both and get the best of both worlds. For example, contribute to your RRSP each year, and use the tax refund to pay down your mortgage. Finding a balance between chipping away at your mortgage and saving for retirement is a form of diversification that could benefit you in the long run.
The above is general information and is not intended to be financial advice, and may not be suitable for you. Before you make a decision, we recommend you consult with a qualified financial advisor about which strategy might be right for you.
This article is provided by First National Financial. For more information call 888.488.0794 or visit www.firstnational.ca.