January 1996

Maximize RRSP or
Pay Down Mortgage?

© Talbot Stevens

Evaluating whether you are financially better off contributing to an RRSP or paying down any non-deductible debt like a mortgage involves many parameters, but extensive research of numerous scenarios revealed that only two are significant. One: the difference between the interest rate of the debt and the average growth rate of the RRSP. Two: the percentage of mortgage payments that is invested into an RRSP after the mortgage is paid off.

Obviously, if you never invested any of the new disposable income that results when the mortgage is gone, you would be better off building your RRSP because at some point you would eventually have both a debt-free home and an RRSP.

Mathematics. Most people will end up with a larger retirement fund by maximizing their RRSP before paying down any debt, unless the interest charged on the debt is at least 3% higher than your average RRSP return.

For example, if you expect your RRSP to average 10% growth a year, then you should only pay down debts that charge more than 13%. This assumes that you will invest less than two-thirds of your mortgage payments once the mortgage is paid off.

Therefore, paying down bank and department store credit cards rank ahead of RRSPs, but generally not mortgages.

Security First. But the more important reason to contribute to an RRSP before paying down any debt has nothing to do with the mathematics. The real reason that most people should contribute to their RRSP first is to establish an emergency fund to protect against low- or no-income periods that have become an all-too-real part of today's economic environment.

Once an adequate “RRSP emergency buffer” has been established, you have the peace of mind of knowing that several years of mortgage payments can be made before being in danger of losing your home. This is especially important to those with their own business, where income is irregular and often unpredictable.

If you are forced to use your RRSP for emergency funds, you will probably be in a lower tax bracket, which means the government partially subsidizes this “RRSP income insurance plan”. And if you never cash in the “income insurance plan”, it doesn't cost you because you still have the money for its original purpose — retirement.

Whether you use it in the next few years after a layoff or decades later during retirement, the most important reason to contribute to your RRSP is for the financial security — the peace of mind of knowing that your financial survival doesn't depend on your employer, or the government.

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