With the RRSP deadline looming, many Canadians are trying to make sense of their investment options. Personal debt levels in Canada have hit record highs, most of us don’t have a pension to fall back on and our retirement savings are far from adequate. Which leads us to the perennial problem: Should Canadian’s focus on paying off their mortgage and lowering debt or invest in RRSPs?
The classic non-answer answer is “do both”. For some, it’s as easy as contributing to an RRSP and then using the refund to pay down debts. Sounds easy, right? Until you realize that very few people fall into this clearcut solution. If “doing both” doesn’t really work for your financial situation, don’t despair. There are a few additional options worth considering.
Understanding the Math
If you contribute to your Registered Retirement Savings Plan (RRSP), you will pay less tax. On the other hand, if you pay down your debt, you will pay less interest. So which is better? Ultimately, this depends on your personal financial situation. First things first – grab a calculator and crunch some numbers. Compare the rate of return you’re getting from your RRSP investments against the interest rate you’re paying on your mortgage. This will help provide you with a better basis for your decision.
Next, take a closer look at your debt. What exactly does it cost you each month? Each year? Are there fees and penalties if you pay of your debt faster (example, making extra mortgage payments)? Now, consider how you will invest your RRSP contribution. Do you plan to put your money into a safe investment that guarantees your return? Or are you looking at riskier equities? What will it cost you to invest? How much tax will you save if you contribute to your RRSP?
The Importance of Discipline
Discipline is an important factor when it comes to planning your investment strategy. For examples, let’s assume you have $30,000 in mortgage debt. You could potentially pool your money towards paying off this debt years early, which in turn would save you a ton in interest payments. But this only makes sense if you plan to invest the money you’ve saved. If you don’t have the discipline to invest, it makes more sense to contribute to your RRSP now as this will help you end up with a debt-free home and retirement funds… even if it takes slightly longer. Only the most disciplined of homeowners will be dedicated enough to invest every penny of their mortgage payments after they’re debt-free.
Other Factors to Consider
Aside from discipline, Canadian’s need to consider the following factors before making a final decision:
- Type of Debt
The higher the interest rate on your debt, the quicker you will want to pay it down. For example, credit card debt carries an extremely high interest rate. When you’re trying to decide which debt to pay off first, take a look at the small print. Not all debt works the same. - Amount of Debt
If you’re carrying a large about of high-interest debt, you’re also paying a large amount of interest. If you owe a smaller about of debt, your interest may be more reasonable. Adding money to your RRSP could make more sense in this case, as the tax refund could help you pay off your debt faster. - Your Age
If you’re closing in on retirement, you may want to focus on paying off your debt as quickly as possible. Most financial experts recommend going into retirement mortgage and debt-free. - Your Tax Bracket
If you fall into a higher tax bracket now, you may want to make an RRSP contribution in order to lower your taxes. If you expect to be in a higher tax bracket come retirement, you may want to pay down debt now. Consult with a financial advisor for more information. - Type of RRSP
There may be additional benefits to contributing to your RRSP now. For example, some companies match RRSP contributions. Taking advantage of these added perks could help you reach your long term financial goals sooner.