RRSP or Extra Mortgage Payments?
Chances are if you are reading this and you own a home, you have a mortgage on that home, and like most of us, you would like to get rid of that pesky mortgage payment each month. Many of you likely had parents, like mine, who instilled the notion of paying down that mortgage as fast as possible.
Heeding mom and dad’s normally wise advice, you have run into your bank or called your mortgage company and are doing accelerated mortgage payments or privilege payments each year when the mortgage company lets you put extra amounts down on your principal without penalty.
While your mom and dad would, no doubt, be proud, making these extra or accelerated mortgage payments may not be the best thing depending on your situation. In fact, in some cases, this choice can cost you thousands of extra dollars in unnecessary taxes.
If you have earned income and RRSP room, your RRSP is very likely the better place for those extra dollars. When you put money into an RRSP, you save the income tax you would have paid on that income which is at your marginal tax rate. Each tax situation will differ but if you made up to $42,000+/-, you will recover about 20% of what you contribute to an RRSP for those earning amounts; over $42,000 and up to about $83,000, your tax savings climbs due to your higher marginal rate to approximately 30% and on those earnings over $83,000, you can expect about 36% in tax savings.
Considering that mortgage rates are very low right now and even if you are in the lowest tax bracket and your mortgage is at 5%, putting those hard earned dollars in an RRSP will save you about 15% more than making accelerated payments on your mortgage.
Add to this the fact that you have put away additional money for those golden years and if that doesn’t make mom and dad proud then take your tax refund that you likely created with your additional RRSPs and put it down on your mortgage or even better roll that refund into more RRSPs (essentially generating tax savings on your tax savings).
Consider the case of Jim, who earns $65,000 and does $4,000 of privilege payments to his mortgage annually. Now he routes this money to his RRSP rather than to his mortgage and generates $1,200 of tax savings each year in the process saving himself $6,000 of additional tax in 5 years and building himself a retirement nest egg of $20,000. If Jim decides to take his RRSP refund of $1,200 and invest in more RRSPs each year (ie., rolling his refund into his RRSP portfolio), his tax savings would grow to $7,839 and his RRSP portfolio would be almost $34,000 plus any growth or interest on the funds.
Bottom line is that an RRSP remains a very effective tool to save taxes and build up savings for retirement years and mom and dad would be proud of you for your smart strategy.